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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006
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
incorporation or organization) Identification No.)
1010 MANVEL AVENUE, CHANDLER, OKLAHOMA 74834
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (405) 258-0804
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
-------------------------------- --------------------------------------------
8.75% SENIOR DEBENTURES DUE 2014 AMERICAN STOCK EXCHANGE
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. YES NO X
-- --
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. YES NO X
-- --
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 NO X
-- --
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. X
--
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 Act). YES NO X
-- --
Aggregate market value of the voting stock held by non-affiliates of the
registrant on June 30, 2006, the last business day of the registrant's most
recently completed second fiscal quarter: None.
The number of common shares, $1.00 par value, of the registrant
outstanding on February 28, 2007 was 2,484, which are owned by Chandler
Insurance Company, Ltd.
DOCUMENTS INCORPORATED BY REFERENCE
Registrant does not incorporate by reference in this report any annual
report, proxy statement, or Rule 424 prospectus.
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PAGE 1
PART I
FORWARD-LOOKING STATEMENTS
Some of the statements made in this Form 10-K 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
including ongoing litigation matters.
ITEM 1. BUSINESS.
GENERAL
Chandler USA is an insurance holding company that provides administrative
services to its wholly owned subsidiaries NAICO and Chandler Insurance
Managers, Inc. ("CIMI"). Chandler USA is an Oklahoma corporation which is
wholly owned by Chandler Insurance Company, Ltd. ("Chandler Insurance"), a
privately owned Cayman Islands company. Chandler USA is headquartered in
Chandler, Oklahoma, in facilities also occupied by NAICO and CIMI.
NAICO is one of the leading commercial business insurance writers in
Oklahoma, providing property and casualty insurance products for businesses
in various industries. NAICO has a network of independent agents, totaling
approximately 149 at December 31, 2006, that market NAICO's insurance products.
Independent agents originate substantially all of NAICO's business. NAICO is
licensed to write property and casualty coverage in 45 states and the District
of Columbia and is authorized by the United States Department of the Treasury
to write surety bonds for contractors on federal projects. NAICO is currently
rated as B+ (Very Good) by A.M. Best Company, an insurance rating agency. This
rating is an independent opinion of a company's financial strength, operating
performance and ability to meet its obligations to policyholders.
CIMI is an underwriting manager and wholesaler that offers multiple
insurance products for businesses in various industries and political
subdivisions.
INSURANCE PROGRAMS
NAICO writes various property and casualty insurance products through two
primary marketing programs. The programs are standard lines and political
subdivisions.
STANDARD LINES PROGRAM
NAICO offers workers compensation, automobile liability and physical
damage and other liability (including general liability, products liability
and umbrella liability) coverages under its standard lines program. In
marketing these products, NAICO targets companies in the construction,
manufacturing, wholesale, service, oil and gas, trucking, and retail
industries. NAICO writes this business principally in Oklahoma and Texas.
NAICO has also written property and inland marine coverages in this
program. Effective January 1, 2007, the property and inland marine lines of
insurance that were previously written by NAICO in the standard lines and
political subdivisions programs will be written by Praetorian Insurance
Company ("Praetorian") through an arrangement between Praetorian and CIMI.
NAICO also transferred its existing property and inland marine business in
these programs to Praetorian under this new arrangement effective January
1, 2007. Under this arrangement, CIMI receives commission income for the
business it produces for Praetorian. CIMI is responsible for the payment of
commissions to the producing agents, and is also responsible for providing
underwriting and loss control services for this business. NAICO handles all
claims for this business under a separate claims handling agreement with
Praetorian.
PAGE 2
Management believes this new arrangement will allow Chandler USA's
subsidiaries to offer more competitive property and inland marine programs for
its agents. In addition, NAICO will no longer be required to purchase
reinsurance for the significant insured values associated with this business.
POLITICAL SUBDIVISIONS PROGRAM
Under the political subdivisions program, NAICO writes insurance policies
primarily for school districts in Oklahoma. As of December 31, 2006, NAICO
insured 137 school districts in Oklahoma. The coverages offered include
workers compensation, automobile liability, automobile physical damage,
general liability and school board legal liability. NAICO has also written
property and inland marine coverages in this program. Effective January 1,
2007, the property and inland marine lines of insurance will be written by
Praetorian.
HOMEOWNERS PROGRAM
In 2005, NAICO began writing homeowners and dwelling fire and allied
lines policies in the state of Texas through a managing general agent. NAICO
discontinued this program during the second quarter of 2006 due primarily to
increased catastrophic exposures.
SURETY BOND PROGRAM
NAICO has written surety bonds, commonly referred to as contract
performance bonds, to secure the performance of contractors and suppliers on
construction projects. NAICO has also written bail bonds, which guarantee
that the principal will discharge obligations set by the court, as well as
other types of miscellaneous bonds. NAICO discontinued the bail bond portion
of the program as of the end of 2003. NAICO is no longer actively marketing
its surety bond program.
The following table shows gross premiums earned and net premiums earned
by insurance program for the years 2004, 2005 and 2006. The term "gross
premiums earned" means gross premiums written (before reductions for premiums
ceded to reinsurers) less the increases or plus the decreases in the gross
unearned premium reserve for the unexpired portion of the policy term beyond
the current accounting period. The term "net premiums earned" means gross
premiums earned less reductions for earned premiums ceded to reinsurers. See
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS."
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
-------------------------- --------------------------
INSURANCE PROGRAMS 2004 2005 2006 2004 2005 2006
- ----------------------------- -------- -------- -------- -------- -------- --------
(In thousands)
Standard lines .............. $ 92,894 $ 92,224 $ 91,153 $ 54,278 $ 54,979 $ 54,357
Political subdivisions ...... 21,679 18,630 14,337 7,269 6,690 5,253
Homeowners .................. - 4,229 8,542 - 3,321 5,353
Surety bonds ................ 2,788 930 278 1,993 669 193
Other (1) ................... 507 406 550 502 401 548
-------- -------- -------- -------- -------- --------
TOTAL ....................... $117,868 $116,419 $114,860 $ 64,042 $ 66,060 $ 65,704
======== ======== ======== ======== ======== ========
- -------------------------
<FN>
(1) This category is comprised primarily of the run-off of discontinued programs and
NAICO's participation in various mandatory workers compensation pools.
PAGE 3
LINES OF INSURANCE
The lines of insurance written by NAICO through its programs are
automobile liability, other liability (including general liability, products
liability and umbrella liability), workers compensation, automobile physical
damage, property (including homeowners multiple peril), surety and inland
marine. The following table shows net premiums earned as a percentage of
total net premiums earned by each line of insurance written by NAICO during
the period indicated.
YEAR ENDED DECEMBER 31,
--------------------------------------------
2002 2003 2004 2005 2006
-------- -------- -------- -------- --------
Automobile liability .................... 25% 27% 28% 29% 32%
Other liability ......................... 25% 23% 28% 27% 25%
Workers compensation .................... 22% 29% 27% 25% 23%
Property ................................ 8% 5% 4% 8% 11%
Automobile physical damage .............. 14% 10% 9% 9% 8%
Inland marine ........................... 1% 1% 1% 1% 1%
Surety .................................. 5% 5% 3% 1% -%
-------- -------- -------- -------- --------
Total .............................. 100% 100% 100% 100% 100%
======== ======== ======== ======== ========
NAICO discontinued its homeowners program during 2006, and has also
transferred its property and inland marine business for the standard lines
and political subdivisions programs to Praetorian effective January 1, 2007
through a new arrangement between Praetorian and CIMI. Because of these
changes, NAICO expects its 2007 net premiums earned for property and inland
marine business to be minimal. See "Insurance Programs" for more information.
AGENCY AND BROKERAGE
CIMI serves as a general agent for certain wholesale insurance operations
related to NAICO's school districts and trucking insurance. Under its general
agency agreement with NAICO, CIMI was appointed to accept, in accordance with
NAICO's underwriting guidelines, certain surety bonds and property and casualty
insurance. CIMI is also authorized to secure qualified insurance agents for
NAICO and shall assist NAICO in coordinating the agents' activities.
Effective January 1, 2007, CIMI administers certain property and inland
marine business for Praetorian under a general agency agreement between the
parties. CIMI receives commission income for its services under the agreement,
and is responsible for the payment of commissions to the producing agents.
CIMI is also responsible for providing underwriting and loss control services
for this business. See "Insurance Programs" for more information.
UNDERWRITING AND CLAIMS
Independent insurance agents submit applications for commercial insurance
policies for prospective customers to NAICO or CIMI. Prospective risks are
reviewed in accordance with specific underwriting guidelines. If the risk is
approved and coverage is accepted by the insured, an insurance policy is
issued.
NAICO's claims department reviews and administers all claims except
claims associated with the homeowners program which are handled by the
managing general agent for this program. When a claim is received, it is
reviewed and assigned to an in-house claim adjuster based on the type and
geographic location of the claim, its severity and its class of business.
NAICO's claims department is responsible for reviewing each claim, obtaining
necessary documentation and establishing loss and loss adjustment expense
reserves. NAICO's in-house claims staff handles and supervises the claims,
coordinates with outside legal counsel and independent claims adjusters if
necessary, and processes the claims to conclusion. Effective January 1,
2007, NAICO also handles claims for the property and inland marine business
placed by CIMI with Praetorian under a claims handling agreement with
Praetorian.
PAGE 4
REINSURANCE
In the ordinary course of business, NAICO cedes insurance risks and a
portion of the insurance premiums to its reinsurers under various reinsurance
contracts that cover individual risks (facultative reinsurance) or entire
classes of business (treaty reinsurance). Reinsurance provides greater
diversification of insurance risk associated with business written and also
reduces NAICO's exposure from high policy limits or from catastrophic events
and hazards of an unusual nature. Amounts recoverable from reinsurers are
estimated in a manner consistent with the claim liability associated with the
reinsured policies. In formulating its reinsurance programs, NAICO considers
numerous factors, including the financial stability of the reinsurer, the
reinsurer's ability to provide sufficient collateral (if required),
reinsurance coverage offered and price.
Treaty reinsurance may be ceded under treaties on both a pro rata
basis (where the reinsurer shares proportionately in premiums and losses)
and an excess of loss basis (where only losses above a specific amount
are reinsured). The availability, costs and limits of reinsurance
purchased varies from year to year based upon prevailing market conditions,
reinsurers' underwriting results and NAICO's desired risk retention levels.
A majority of NAICO's reinsurance programs renew on January 1 or July 1 of
each year. NAICO renewed all applicable January 1, 2007 reinsurance programs.
At the present time, NAICO expects to renew the reinsurance programs that
renew on July 1, 2007.
NAICO has structured separate reinsurance programs for property (including
inland marine), workers compensation, casualty (including automobile liability,
general and products liability, umbrella liability and related professional
liability), automobile physical damage, homeowners and construction surety
bonds. NAICO also purchases facultative reinsurance when it writes a risk
with limits of liability exceeding the maximum limits of its treaties or when
it otherwise considers such action appropriate. Chandler Insurance reinsures
NAICO for a portion of the risk on NAICO's reinsurance programs except for the
homeowners program. NAICO discontinued its property reinsurance program
effective January 1, 2007 due to the transfer of its property business for the
standard lines and political subdivisions programs to Praetorian.
Effective July 1, 2003, NAICO's net retention under the workers
compensation reinsurance program was 70% of the first $500,000 of loss per
occurrence, plus 56% of $500,000 excess of $500,000 of loss per occurrence.
Effective July 1, 2004, NAICO's net retention increased to 70% of the first
$1,000,000 of loss per occurrence.
Effective July 1, 2003, NAICO's net retention under the casualty
reinsurance program was 70% of the first $500,000 of loss per occurrence,
plus 56% of $500,000 excess of $500,000 of loss per occurrence. Effective
July 1, 2004, NAICO's net retention increased to 70% of the first $1,000,000
of loss per occurrence. Effective July 1, 2005, NAICO increased its net
retention to 70% of the first $2,000,000 of loss per occurrence. Effective
July 1, 2004, NAICO's net retention for umbrella liability losses was 17.5%
of the first $4,000,000 of loss per occurrence. Effective July 1, 2006, NAICO
decreased its net retention for umbrella liability losses to 10.5% of the
first $4,000,000 of loss per occurrence.
Effective April 1, 2003, NAICO retains 70% of the losses in the
construction surety bond portion of the surety bond program.
Under the 2004, 2005 and 2006 property reinsurance programs, NAICO
retained 23.1% of the first $3,000,000 of risk for each loss per risk or
location. NAICO discontinued its property reinsurance program effective
January 1, 2007 due to the transfer of its property business for the
standard lines and political subdivisions programs to Praetorian. Under the
2004, 2005 and 2006 automobile physical damage reinsurance programs NAICO
retained 70% of each loss per occurrence. NAICO has purchased catastrophe
protection for its automobile physical damage and certain property coverages
to limit its retention for single loss occurrences involving multiple policies
and/or policyholders resulting from perils such as floods, winds and severe
storms. This catastrophe protection limits NAICO's net retained loss for both
automobile physical damage and property losses to $1,400,000 effective January
1, 2004 for each loss occurrence. NAICO retains 75% of the risk under the
homeowners program, with per occurrence excess of loss treaties maintained
covering 100% of $28,000,000 excess of $2,000,000.
In December 2005, the Terrorism Risk Insurance Act of 2002 (the "Act")
was extended through December 31, 2007. The Act establishes a program for
commercial property and casualty losses resulting from foreign acts of
terrorism. The Act requires commercial insurers to offer terrorism coverage
on its commercial property and casualty lines of business. Effective January
1, 2006, commercial automobile liability and physical damage, professional
liability, surety, burglary and theft and farm-owners multi-peril insurance
coverages are excluded from the Act. Each insurance company will be
responsible for a deductible based on a percentage of direct earned premiums
from the previous calendar year, which is 17.5% for losses occurring in 2006
and 20% in 2007. The Federal Government will pay 90% of covered terrorism
losses that exceed company deductibles.
PAGE 5
NAICO purchased quota share reinsurance for its deductible under the Act
limiting NAICO's retention to 15% for 2005 and 2006 of such deductible, subject
to a reinsurance limit of $10,625,000 for 2005 and 2006 for each loss
occurrence. The reinsurance coverage is also limited to $10,625,000 for 2005
and 2006 for all loss occurrences for any year. NAICO also purchased excess
of loss reinsurance covering acts of terrorism that provides coverage of $15
million excess of $12.5 million for 2005 and 2006 of loss per occurrence based
on NAICO's net retention. Effective January 1, 2007, NAICO purchased excess of
loss reinsurance covering acts of terrorism that provides coverage of
$24,900,000 excess of $100,000 for NAICO's deductible under the Act, as well
as for acts of terrorism other than those covered under the Act.
The following table sets forth certain information related to NAICO's
five largest reinsurers determined on the basis of net reinsurance
recoverables as of December 31, 2006.
CEDED REINSURANCE
NET PREMIUMS FOR A.M. BEST
REINSURANCE THE YEAR ENDED COMPANY
NAME OF REINSURER RECOVERABLE (1) DECEMBER 31, 2006 RATING
- ----------------------------------------------------------- --------------- ------------------- -----------
(Dollars in thousands)
Chandler Insurance ........................................ $ 29,090 $ 27,156 (2)
Employers Reinsurance Corporation ......................... 21,325 3,327 A
Swiss Reinsurance America Corporation ..................... 12,725 241 A+
Odyssey America Reinsurance Corporation ................... 4,848 4,092 A
XL Reinsurance America Inc. ............................... 2,052 661 A+
--------------- -------------------
Top five reinsurers .................................. $ 70,040 $ 35,477
=============== ===================
All reinsurers ....................................... $ 63,368 $ 48,254
=============== ===================
Percentage of total represented by top five reinsurers .... 111% 74%
- --------------------------------------------------------------
<FN>
(1) Includes losses and loss adjustment expenses paid and outstanding, unpaid
losses and loss adjustment expenses and prepaid reinsurance premiums
recoverable from reinsurers as of December 31, 2006. The net amount
recoverable from all reinsurers is less than the net amount recoverable
for the top five reinsurers due to a significant amount of estimated
recoveries that were ceded to reinsurers other than those listed above.
See "Reserves" for more information.
(2) Chandler Insurance owns 100% of the common stock of Chandler USA, which
in turn owns 100% of the common stock of NAICO. Chandler Insurance does
not have an A.M. Best Company rating. Although Chandler Insurance is
not subject to the minimum capital, audit, reporting and other
requirements imposed by regulation upon United States reinsurance
companies, as a foreign reinsurer, it is required to secure its
reinsurance obligations by depositing acceptable securities in trust for
NAICO's benefit. At December 31, 2006, Chandler Insurance had cash and
investments, including accrued interest, with a fair value of $28.3
million deposited in a trust account for the benefit of NAICO.
Reinsurance contracts do not relieve an insurer from its obligation to
policyholders. Failure of reinsurers to honor their obligations could result
in losses to Chandler USA; consequently, adjustments to ceded losses and loss
adjustment expenses are made for amounts deemed uncollectible. NAICO incurred
charges of $282,000, $108,000 and $97,000 during 2004, 2005 and 2006,
respectively, in adjustments to ceded losses and loss adjustment expenses for
amounts deemed uncollectible.
LOSS AND UNDERWRITING EXPENSE RATIOS
The combined loss and underwriting expense ratio ("Combined Ratio") is
the traditional measure of underwriting experience for property and casualty
insurance companies. It is the sum of the ratios of (i) incurred losses and
loss adjustment expenses to net premiums earned ("loss ratio") and (ii)
underwriting expenses to net premiums written and assumed ("underwriting
expense ratio").
PAGE 6
The following table shows the underwriting experience of Chandler USA for
the periods indicated by line of insurance written. Adjustments to reserves
made in subsequent periods are reflected in the year of adjustment. In the
following table, incurred losses include paid losses and loss adjustment
expenses, net changes in case reserves for losses and loss adjustment expenses
and net changes in reserves for incurred but not reported losses and loss
adjustment expenses. See also "Reserves" and "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS."
YEAR ENDED DECEMBER 31,
------------------------------------------------
2002 2003 2004 2005 2006
-------- -------- -------- -------- --------
(Dollars in thousands)
Automobile liability:
Net premiums earned ........................ $ 16,526 $ 15,624 $ 17,742 $ 19,126 $ 21,122
Loss ratio ................................. 81% 49% 61% 82% 99%
Other liability:
Net premiums earned ........................ $ 16,458 $ 12,870 $ 18,044 $ 18,052 $ 16,628
Loss ratio ................................. 80% 94% 121% 48% 57%
Workers compensation:
Net premiums earned ........................ $ 14,808 $ 16,378 $ 17,371 $ 16,475 $ 15,361
Loss ratio ................................. 99% 72% 85% 53% 63%
Automobile physical damage:
Net premiums earned ........................ $ 9,552 $ 5,508 $ 5,933 $ 5,807 $ 5,008
Loss ratio ................................. 35% 36% 43% 56% 63%
Property:
Net premiums earned ........................ $ 5,543 $ 3,072 $ 2,611 $ 5,594 $ 7,082
Loss ratio ................................. 50% 74% 47% 41% 41%
Surety:
Net premiums earned ........................ $ 3,310 $ 2,723 $ 1,993 $ 669 $ 194
Loss ratio ................................. 59% 34% 134% (255)% (459)%
Inland marine:
Net premiums earned ........................ $ 760 $ 408 $ 348 $ 337 $ 309
Loss ratio ................................. 100% 54% 29% 162% 30%
Total:
Net premiums earned ........................ $ 66,957 $ 56,583 $ 64,042 $ 66,060 $ 65,704
Loss ratio ................................. 76% 66% 84% 57% 69%
Underwriting expense ratio (1) ............. 34% 47% 34% 35% 37%
-------- -------- -------- -------- --------
Combined ratio (1) ......................... 110% 113% 118% 92% 106%
======== ======== ======== ======== ========
- ------------------------------------------------
<FN>
(1) Interest expense and certain litigation expenses are not considered underwriting expenses;
therefore, such costs have been excluded from these ratios. The underwriting expense ratio for
2003 was impacted by a 23% decrease in net premiums written and assumed during 2003. Certain
types of expenses are fixed in nature, which resulted in an increased ratio for this period.
RESERVES
Insurance companies provide in their financial statements reserves for
unpaid losses and loss adjustment expenses which are estimates of the expense
of investigation and settlement of all reported and incurred but not reported
losses under their previously issued insurance policies and/or reinsurance
contracts. In estimating reserves, insurance companies use various
standardized methods based on historical experience and payment and reporting
patterns for the type of risk involved. The application of these methods
involves subjective determinations by the personnel of the insurance company.
Inherent in the estimates of the ultimate liability for unpaid claims are
expected trends in claim severity, claim frequency and other factors that may
vary as claims are settled. The amount of and uncertainty in the estimates is
affected by such factors as the amount of historical claims experience relative
to the development period for the type of risk, knowledge of the actual facts
and circumstances and the amount of insurance risk retained. The ultimate
cost of insurance claims can be adversely affected by increased costs, such as
medical expenses, repair expenses, costs of providing legal defense for
policyholders, increased jury awards and court decisions and legislation that
expand insurance coverage after the insurance policy was priced and sold. In
recent years, certain of these factors have contributed to incurred amounts
that were higher than original estimates. Accordingly, the loss and loss
adjustment expense reserves may not accurately predict an insurance company's
ultimate liability for unpaid claims.
PAGE 7
NAICO periodically reviews the reserve estimates relating to insurance
business written or assumed by NAICO, and the methods used to arrive at such
reserve estimates. NAICO also retains independent professional actuaries who
review such reserve estimates and methods. Any changes in the estimates are
reflected in current operating results. Such changes in estimates may be
material. NAICO's statutory-based reserves (reserves calculated in accordance
with an insurer's domiciliary state insurance regulatory authorities) do not
differ from its reserves reported on the basis of accounting principles
generally accepted in the United States of America ("GAAP"). NAICO does not
discount its reserves for unpaid losses or loss adjustment expenses.
Salvage and subrogation recoverables are accrued using the "case basis"
method for large recoverables and statistical estimates based on historical
experience for smaller recoverables. Recoverable amounts deducted from
Chandler USA's net liability for losses and loss adjustment expenses were
approximately $9.6 million and $13.2 million at December 31, 2005 and 2006,
respectively. The increase in estimated recoveries in 2006 is due primarily
to NAICO recording net estimated recoveries totaling $5.6 million related to a
favorable jury verdict in civil litigation regarding certain surety bond
claims during 2006. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS" for more information related to this
litigation. The gross and net estimated recovery deducted from unpaid losses
and loss adjustment expenses related to this litigation at December 31, 2006
is $31.5 million and $10.8 million, respectively. NAICO may or may not
recover the above estimated recoveries and could incur significant costs in
collecting these recoverables.
NAICO participates in various pools covering workers compensation risks
for insureds who were unable to purchase this coverage from an insurance
company on a voluntary basis. The consolidated financial statements reflect
the reserves for unpaid losses and loss adjustment expenses and net premiums
earned from its participation in the pools.
There may be significant reporting lags between the occurrence of the
insured loss and the time it is actually reported to the insurer. The
inherent uncertainties in estimating insurance reserves are generally greater
for casualty coverages, such as workers compensation, general and automobile
liability, than for property coverages primarily due to the longer period of
time that typically elapses before a definitive determination of ultimate
loss can be made, which is also affected by changing theories of legal
liability and changing political climates.
There are significant additional uncertainties in estimating the amount
of reserves required for environmental, asbestos-related and other latent
exposure claims, including a lack of historical data, long reporting delays
and complex unresolved legal issues regarding policy coverage and the extent
and timing of any such contractual liability. Courts have reached different
and frequently inconsistent conclusions as to when the loss occurred, what
claims are covered, under what circumstances the insurer has an obligation to
defend, how policy limits are determined and how policy exclusions are applied
and interpreted.
The loss settlement period on insurance claims for property damage is
relatively short. The more severe losses for bodily injury and workers
compensation claims have a much longer loss settlement period and may be paid
out over several years. It is often necessary to adjust estimates of
liability on a loss either upward or downward from the time a claim arises
to the time of payment. Workers compensation indemnity benefit reserves are
determined based on statutory benefits described by state law and are
estimated based on the same factors generally discussed above which may
include, where state law permits, inflation adjustments for rising benefits
over time. Generally, the more costly automobile liability claims involve one
or more severe bodily injuries or deaths. The ultimate cost of these types
of claims is dependent on various factors including the relative liability of
the parties involved, the number and severity of injuries and the legal
jurisdiction where the incident occurred.
PAGE 8
The following table sets forth a reconciliation of the beginning and
ending reserves for losses and loss adjustment expenses which are net of
reinsurance deductions for the years indicated.
YEAR ENDED DECEMBER 31,
------------------------------------------------------
2002 2003 2004 2005 2006
---------- ---------- ---------- ---------- ----------
(In thousands)
Net balance at beginning of year .................... $ 32,812 $ 33,191 $ 29,343 $ 44,695 $ 40,549
---------- ---------- ---------- ---------- ----------
Net losses and loss adjustment expenses incurred
related to:
Current year .................................. 34,928 26,108 27,436 30,985 41,644
Prior years ................................... 15,784 11,092 26,345 6,339 3,829
---------- ---------- ---------- ---------- ----------
Total ...................................... 50,712 37,200 53,781 37,324 45,473
---------- ---------- ---------- ---------- ----------
Net paid losses and loss adjustment expenses
related to:
Current year .................................. (13,283) (10,626) (10,222) (11,171) (12,403)
Prior years ................................... (37,050) (30,422) (28,207) (30,299) (31,538)
---------- ---------- ---------- ---------- ----------
Total ...................................... (50,333) (41,048) (38,429) (41,470) (43,941)
---------- ---------- ---------- ---------- ----------
Net balance at end of year .......................... $ 33,191 $ 29,343 $ 44,695 $ 40,549 $ 42,081
========== ========== ========== ========== ===========
NAICO has experienced a significant amount of incurred losses related
to prior accident years during the 2002-2005 calendar years. The adverse
loss development is generally the result of ongoing analysis of loss
development trends for both liability and workers compensation lines of
business, and includes provisions for potentially uncollectible reinsurance
and deductibles. NAICO adjusts reserves as experience develops and new
information becomes known. Such adjustments are reflected in the results
of operations in the periods in which the estimates are changed. The
adverse development of losses from prior accident years results in higher
calendar year loss ratios and reduced calendar year operating results.
During 2002, NAICO experienced adverse loss development totaling $15.8
million primarily in the standard lines program including both liability
lines and workers compensation. This adverse development was primarily due
to an increase in loss severity within the 1997-2000 accident years. The
adverse development included approximately $2.0 million for provisions for
potentially uncollectible reinsurance and deductibles.
During 2003, NAICO experienced adverse loss development totaling $11.1
million primarily in the standard lines program. This adverse development
was due primarily to an increase in losses in the workers compensation and
other liability lines of business in the 1998-2001 accident years. A
reduction in losses for the 2002 accident year partially offset this adverse
development. The adverse loss development included approximately $1.3 million
for provisions for potentially uncollectible reinsurance and deductibles.
During 2004, NAICO experienced adverse loss development totaling $26.3
million primarily in the standard lines and political subdivisions programs.
This adverse development was due primarily to an increase in losses in the
workers compensation and other liability lines of business in the 1997-2002
accident years. The adverse development in the 2002 accident year partially
offset the reduction in losses for this accident year that was recorded during
2003. The adverse loss development included approximately $409,000 for
provisions for potentially uncollectible reinsurance and deductibles. Reserves
for unpaid losses and loss adjustment expenses, net of related reinsurance
recoverables, were $44.7 million at December 31, 2004 compared to $29.3 million
at December 31, 2003, an increase of $15.4 million or 52%.
During 2005, NAICO experienced adverse loss development totaling $6.3
million primarily in the standard lines and political subdivisions programs.
A portion of the adverse development was offset by favorable development of
$1.8 million in the surety bond program, primarily in accident years 1994 and
2001 that resulted from the estimated recoveries discussed previously. The
adverse development was due primarily to an increase in losses in the workers
compensation, other liability and automobile liability lines of business in the
2000, 2002 and 2003 accident years. The adverse loss development included
approximately $108,000 for provisions for potentially uncollectible reinsurance.
PAGE 9
During 2006, NAICO experienced adverse loss development totaling $3.8
million primarily in the standard lines program. A portion of the adverse
development was offset by favorable development of $1.0 million in the surety
bond program, primarily in the 2001 accident year, that resulted from the
estimated recoveries discussed previously. The adverse development was due
primarily to an increase in losses in the automobile liability line of
business in the 2005 accident year and in the workers compensation line of
business in the 1997 and 1999 accident years. The adverse loss development
included approximately $97,000 for provisions for potentially uncollectible
reinsurance.
The following table represents the development of net balance sheet
reserves for 1997 through 2006. The top line of the table shows the net
reserves at the balance sheet date for each of the indicated years. This
represents the estimated amounts of claims and claim expenses, net of
reinsurance deductions, arising in the current and all prior years that are
unpaid at the balance sheet date, including the net reserve for incurred but
not reported claims. The upper portion of the table shows the cumulative net
amounts paid as of successive years with respect to that reserve liability.
The estimate for unpaid losses and loss adjustment expenses changes as more
information becomes known about the frequency and severity of claims for
individual years. The next portion of the table shows the revised estimated
amount of the previously recorded net reserve based on experience as of the
end of each succeeding year. The heading "net cumulative (deficiency)
redundancy" represents the cumulative aggregate change in the estimates over
all prior years. The last portion of the table provides a reconciliation of
the net amounts to the gross amounts before any deductions for reinsurance.
The gross cumulative deficiency or redundancy results from the same factors as
those described above for the net amounts, and is also impacted by development
of large claims that exceed NAICO's net retention including umbrella and surety
per principal losses where NAICO has little or no net retention.
In evaluating the information in the following table, it should be noted
that each amount includes the effects of all changes in amounts for prior
periods. For example, the amount of the deficiency recorded in 2000 for
claims that occurred in 1997 will be included in the cumulative deficiency
amount for years 1997, 1998, 1999 and 2000. This table does not present
accident or policy year development data. Conditions and trends that have
affected development of the liability in the past may not necessarily occur
in the future. Accordingly, it may not be appropriate to extrapolate future
deficiencies or redundancies based on this table.
PAGE 10
DEVELOPMENT OF RESERVES
AS OF DECEMBER 31,
----------------------------------------------------------------------------------------------------
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
--------- --------- --------- ---------- ---------- ---------- --------- --------- --------- ---------
(In thousands)
Net reserve for unpaid losses and
loss adjustment expenses ... $ 54,035 $ 39,921 $ 51,378 $ 46,707 $ 32,812 $ 33,191 $ 29,343 $ 44,695 $ 40,549 $ 42,081
Net paid (cumulative) as of
One year later ............. 30,330 23,896 36,009 43,799 37,050 30,422 28,207 30,299 31,537
Two years later ............ 42,934 34,966 58,979 66,141 60,560 51,375 50,158 50,183
Three years later .......... 49,735 45,390 72,052 81,635 77,413 68,643 63,900
Four years later ........... 56,306 51,364 80,860 91,403 89,349 79,591
Five years later ........... 58,843 55,445 86,257 97,700 98,060
Six years later ............ 60,821 58,062 88,859 99,506
Seven years later .......... 62,720 59,135 89,346
Eight years later .......... 63,527 58,706
Nine years later ........... 62,938
Net liability re-estimated as of
One year later ............. 55,772 43,441 56,357 59,376 48,596 44,283 55,688 51,034 44,378
Two years later ............ 56,362 45,373 67,469 74,325 67,903 70,058 61,369 50,989
Three years later .......... 58,176 50,146 77,842 86,377 89,608 73,962 61,216
Four years later ........... 61,096 55,303 83,860 100,408 91,520 74,805
Five years later ........... 62,750 58,060 91,704 102,370 91,700
Six years later ............ 63,629 62,995 92,084 104,227
Seven years later .......... 67,608 62,712 93,873
Eight years later .......... 67,254 63,775
Nine years later ........... 68,135
Net cumulative (deficiency)
redundancy ................. $(14,100) $(23,854) $(42,495) $ (57,520) $ (58,888) $ (41,614) $(31,873) $ (6,294) $ (3,829) $ -
Supplemental gross data:
Gross liability ............ $ 73,721 $ 80,701 $ 98,460 $ 100,173 $ 84,756 $ 92,606 $ 87,768 $108,233 $109,541 $ 83,253
Reinsurance recoverable .... 19,686 40,780 47,082 53,466 51,944 59,415 58,425 63,538 68,992 41,172
--------- --------- --------- ---------- ---------- ---------- --------- --------- --------- ---------
Net liability - end of year. $ 54,035 $ 39,921 $ 51,378 $ 46,707 $ 32,812 $ 33,191 $ 29,343 $ 44,695 $ 40,549 $ 42,081
========= ========= ========= ========== ========== ========== ========= ========= ========= =========
Gross re-estimated
liability - latest ........ $105,603 $135,117 $189,247 $ 260,725 $ 290,587 $ 237,259 $171,816 $144,086 $120,966
Re-estimated recoverable -
latest .................... 37,468 71,342 95,374 156,498 198,887 162,454 110,600 93,097 76,588
--------- --------- --------- ---------- ---------- ---------- --------- --------- ---------
Net re-estimated
liability - latest ....... $ 68,135 $ 63,775 $ 93,873 $ 104,227 $ 91,700 $ 74,805 $ 61,216 $ 50,989 $ 44,378
========= ========= ========= ========== ========== ========== ========= ========= =========
Gross cumulative (deficiency)
redundancy ................. $(31,882) $(54,416) $(90,787) $(160,552) $(205,831) $(144,653) $(84,048) $(35,853) $(11,425)
========= ========= ========= ========== ========== ========== ========= ========= =========
INVESTMENTS
Funds available for investment include Chandler USA's present capital
as well as premiums received and retained under insurance policies and
reinsurance agreements issued by NAICO. Until these funds are required to
be used for the settlement of claims and the payment of operating expenses,
they are invested with the objective of generating income, preserving
principal and maintaining liquidity.
PAGE 11
Investments are purchased to support the investment strategies of
Chandler USA and its subsidiaries, which are developed based on many
factors including rate of return, maturity, credit risk, tax considerations,
regulatory requirements and their mix of business. At the time of purchase,
investments in debt securities that Chandler USA has the positive intent and
ability to hold to maturity are classified as held to maturity and reported at
amortized cost; all other debt securities are reported at fair value.
Investments in debt and equity securities classified as trading are actively
and frequently bought and sold with the objective of generating income on
short-term differences in price. Realized and unrealized gains and losses on
securities classified as trading account assets are recognized in current
operations. Chandler USA has not classified any investments as trading
account assets. Debt securities not classified as held to maturity or
trading and equity securities are classified as available for sale, with the
related unrealized gains and losses excluded from earnings and reported net
of deferred income tax as a separate component of other comprehensive income
until realized. Realized gains and losses on sales of securities are based
on the specific identification method. Declines in the fair value of
securities below their carrying value that are other than temporary are
recognized in earnings.
As of December 31, 2006, all of the investments of NAICO were in
fixed-maturity investments (rated Aa3 or A+ or better by Moody's Investors
Service, Inc. or Standard & Poor's, respectively), equity securities, mutual
funds that invest in equity securities, interest-bearing money market
accounts and collateralized repurchase agreements. NAICO's investment
portfolio is managed by the Investment Committee of its Board of Directors.
For additional information, see Notes to Consolidated Financial Statements.
DEBENTURES
On July 16, 1999, Chandler USA completed a public offering of $24
million principal amount of senior debentures (the "Debentures") with a
maturity date of July 16, 2014. The Debentures were priced at $1,000 each
with an interest rate of 8.75% and are redeemable by Chandler USA on or
after July 16, 2009 without penalty or premium. The indenture governing
the Debentures was amended during 2003 to clarify that purchases of
Debentures by Chandler USA through private treaty or on the open market
for an agreed price of less than the sum of the principal amount and accrued
interest are not considered to be a redemption of the Debentures, and that
any such Debentures purchased by Chandler USA will be cancelled. At December
31, 2006, there was $6,979,000 principal amount of the Debentures outstanding.
Chandler USA's subsidiaries and affiliates are not obligated by the Debentures.
Accordingly, the Debentures are effectively subordinated to all existing and
future liabilities and obligations of Chandler USA's existing and future
subsidiaries. For additional information, see "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS."
TRUST PREFERRED SECURITIES
In May 2003, Chandler USA established Chandler Capital Trust I ("Trust
I") by purchasing all of its common securities for $403,000. Trust I is a
Delaware statutory business trust and is a wholly owned non-consolidated
subsidiary of Chandler USA. On May 22, 2003, Trust I issued $13.0 million
of capital securities (the "Trust I Preferred Securities") to InCapS Funding
I, Ltd., an unaffiliated company established under the laws of the Cayman
Islands, in a private transaction. Trust I used the proceeds from the
issuance to purchase $13,403,000 of 9.75% junior subordinated debentures (the
"Junior Debentures I") of Chandler USA. Distributions on the Junior
Debentures I are payable quarterly at a fixed annual rate of 9.75%. Chandler
USA may defer these payments for up to 20 consecutive quarters, but not
beyond the maturity of the Junior Debentures I, with such deferred payments
accruing interest compounded quarterly. The Junior Debentures I are subject
to a mandatory redemption on May 23, 2033, but they may be redeemed after
five years at a premium of half the fixed rate coupon declining ratably to
par in the 10th year.
The Junior Debentures I are the sole assets of Trust I and Trust I will
distribute any cash payments it receives thereon to the holders of its
preferred and common securities. Distributions on the Trust I Preferred
Securities are payable quarterly at a fixed annual rate of 9.75%. Trust I
may defer these payments for up to 20 consecutive quarters, but not beyond
the maturity of the Trust I Preferred Securities, with such deferred payments
accruing interest compounded quarterly. The Trust I Preferred Securities are
subject to a mandatory redemption on May 23, 2033, but they may be redeemed
after five years at a premium of half the fixed rate coupon declining ratably
to par in the 10th year. All payments by Trust I regarding the Trust I
Preferred Securities are guaranteed by Chandler USA.
PAGE 12
In December 2003, Chandler USA established Chandler Capital Trust II
("Trust II") by purchasing all of its common securities for $217,000. Trust
II is a Delaware statutory business trust and is a wholly owned non-
consolidated subsidiary of Chandler USA. On December 16, 2003, Trust II
issued $7.0 million of capital securities (the "Trust II Preferred
Securities") to InCapS Funding II, Ltd., an unaffiliated company established
under the laws of the Cayman Islands, in a private transaction. Trust II
used the proceeds from the issuance to purchase $7,217,000 of floating rate
junior subordinated debentures (the "Junior Debentures II") of Chandler USA.
Distributions on the Junior Debentures II are payable quarterly at a
floating rate of 4.10% over LIBOR (LIBOR is recalculated quarterly and the
interest rate may not exceed 12.5% prior to January 8, 2009). The interest
rate was 9.47% at December 31, 2006. Chandler USA may defer these payments
for up to 20 consecutive quarters, but not beyond the maturity of the Junior
Debentures II, with such deferred payments accruing interest compounded
quarterly. The Junior Debentures II are subject to a mandatory redemption
on January 8, 2034, but they may be redeemed after five years without penalty
or premium.
The Junior Debentures II are the sole assets of Trust II and Trust II
will distribute any cash payments it receives thereon to the holders of its
preferred and common securities. Distributions on the Trust II Preferred
Securities are payable quarterly at a floating rate of 4.10% over LIBOR
(LIBOR is recalculated quarterly and the interest rate may not exceed 12.5%
prior to January 8, 2009). The interest rate was 9.47% at December 31, 2006.
Trust II may defer these payments for up to 20 consecutive quarters, but not
beyond the maturity of the Trust II Preferred Securities, with such deferred
payments accruing interest compounded quarterly. The Trust II Preferred
Securities are subject to a mandatory redemption on January 8, 2034, but
they may be redeemed after five years without penalty or premium. All
payments by Trust II regarding the Trust II Preferred Securities are
guaranteed by Chandler USA.
In December 2003, the Financial Accounting Standards Board issued
Revised Interpretation No. 46 ("FIN 46R"), CONSOLIDATION OF VARIABLE
INTEREST ENTITIES. FIN 46R provides guidance on the identification of, and
financial reporting for, entities over which control is achieved through
means other than voting rights. FIN 46R is used to determine whether
consolidation is required or, alternatively, whether the variable-interest
model under FIN 46R should be used to account for existing and new entities.
Chandler USA adopted FIN 46R effective January 1, 2004. The result of
adoption was the deconsolidation of the two capital trusts that were created
during 2003 in connection with the issuance of trust preferred securities.
Chandler USA now reports the $20.6 million of junior subordinated debentures
that were issued to the capital trusts on its consolidated balance sheet.
The adoption of FIN 46R had no effect on net earnings.
EMPLOYEES AND ADMINISTRATION
At December 31, 2006, Chandler USA and its subsidiaries had
approximately 216 full-time employees. Chandler USA and its subsidiaries
generally have enjoyed good relations with their employees.
COMPETITION
NAICO operates in a highly competitive industry and faces competition
from domestic and foreign insurers, many of which are larger, have greater
financial, marketing and management resources, have more favorable ratings
by ratings agencies and offer more diversified insurance coverages than
NAICO.
An insurance company's capacity to write insurance policies is dependent
on a variety of factors including its net worth or "surplus," the lines of
business written, the types of risk insured and its profitability. During
the late 1990's and into 2000, property and casualty insurance companies
generally under priced their products, which resulted in poor underwriting
results that were partially offset by investment returns. Interest rates
decreased in 2000 and underwriting results continued to deteriorate for
business written in the late 1990's and into 2000. These factors coupled
with additional potential losses due to terrorism and lower investment
returns caused the industry to increase pricing beginning in the latter half
of 2001. Rate increases continued through 2003 and to a lesser extent in
2004, and the industry's underwriting results have improved. The pricing
environment during 2005 and 2006 experienced downward pressure, particularly
for larger accounts. NAICO was able to increase its pricing for most
coverages from 2001 through 2005. However, the recent industry trend has
been for insurers to maintain or reduce rate levels, and NAICO has reduced
its pricing in certain situations and for certain coverages including
workers compensation during 2006. NAICO continues to experience competition
in all of its programs. NAICO's underwriting philosophy is to forego
underwriting risks from which it is unable to obtain what it believes to be
adequate premium rates.
PAGE 13
REGULATION
REGULATION IN GENERAL
NAICO is subject to regulation by government agencies in the
jurisdictions in which it does business. The nature and extent of such
regulation vary from jurisdiction to jurisdiction, but typically involve
prior approval of the acquisition of control of an insurance company or of
any company controlling an insurance company, regulation of certain
transactions entered into by an insurance company with any of its affiliates,
approval of premium rates, forms and policies used for many lines of
insurance, standards of solvency and minimum amounts of capital and surplus
which must be maintained, establishment of reserves required to be maintained
for unearned premiums, unpaid losses and loss adjustment expenses or for
other purposes, limitations on types and amounts of investments, restrictions
on the size of risks which may be insured by a single company, licensing of
insurers and agents, deposits of securities for the benefit of policyholders
and the filing of periodic reports with respect to financial condition and
other matters. In addition, regulatory examiners perform periodic financial
and market conduct examinations of insurance companies. Such regulation is
generally intended for the protection of policyholders rather than
shareholders or creditors.
NAICO is required to deposit securities with regulatory agencies in
several states in which it is licensed as a condition of conducting
operations in those states.
In addition to the regulatory oversight of NAICO, Chandler Insurance is
also subject to regulation under the laws of the Cayman Islands and Chandler
USA and all of its affiliates are subject to regulation under the insurance
laws of Oklahoma (the "Oklahoma Insurance Code"). The Oklahoma Insurance Code
contains certain reporting requirements including those requiring Chandler
Insurance, as the ultimate parent company, to file information relating to
its capital structure, ownership, and financial condition and the general
business operations of its insurance subsidiaries. The Oklahoma Insurance
Code contains special reporting and prior approval requirements with respect
to transactions among affiliates.
NAICO is also affected by a variety of state and federal legislative and
regulatory measures and judicial decisions that define and extend the risks
and benefits for which insurance is sought and provided. These include
redefinitions of risk exposure in areas such as product liability,
environmental damage and workers compensation. In addition, individual state
insurance departments may prevent premium rates for some classes of insureds
from reflecting the level of risk assumed by the insurer for those classes.
Such developments may adversely affect the profitability of various lines of
insurance. In some cases, these adverse effects on profitability can be
minimized through re-pricing, if permitted by applicable regulations, of
coverages or limitations or cessation of the affected business.
INSURANCE REGULATION CONCERNING CHANGE OR ACQUISITION OF CONTROL
NAICO is a domestic property and casualty insurance company organized
under the Oklahoma Insurance Code. The Oklahoma Insurance Code provides
that the acquisition or change of "control" of a domestic insurer or of any
person that controls a domestic insurer cannot be consummated without the
prior approval of the Oklahoma Department of Insurance. A person seeking to
acquire control, directly or indirectly, of a domestic insurance company or
of any person controlling a domestic insurance company must generally file
with the relevant insurance regulatory authority an application for change
of control containing certain information required by statute and published
regulations and provide a copy of such to the domestic insurer. In Oklahoma,
control is generally presumed to exist if any person, directly or indirectly,
owns, controls, holds with the power to vote or holds proxies representing
10% or more of the voting securities of the insurance company or of any other
person or entity controlling the insurance company. The 10% presumption is
not conclusive and control may be found to exist at less than 10%.
In addition, many state insurance regulatory laws contain provisions that
require pre-notification to state agencies of a change in control of a
non-domestic insurance company admitted in that state. While such
pre-notification statutes do not authorize the state agency to disapprove the
change of control, such statutes do authorize issuance of a cease and desist
order with respect to the non-domestic insurer if certain conditions exist
such as undue market concentration.
Any future transactions that would constitute a change in control of
Chandler Insurance or Chandler USA would also generally require prior approval
by the Oklahoma Department of Insurance and would require pre-acquisition
notification in those states which have adopted pre-acquisition notification
provisions and in which the insurers are admitted. Because such requirements
are primarily for the benefit of policyholders, they may deter, delay or
prevent certain transactions that could be advantageous to the shareholders
or creditors of Chandler USA.
RESTRICTIONS ON SHAREHOLDER DIVIDENDS
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.
PAGE 14
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, 2006, NAICO had statutory earned surplus of $14.0
million. Applying the Oklahoma statutory limits described above, the maximum
shareholder dividend NAICO may pay in 2007 without the approval of the
Oklahoma Department of Insurance is $5.2 million. NAICO paid shareholder
dividends to Chandler USA totaling $3.4 million in 2004.
In addition to the statutory limits described above, the amount of
shareholder dividends and other payments to affiliates permitted 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.
RISK-BASED CAPITAL
The National Association of Insurance Commissioners has adopted a
methodology for assessing the adequacy of statutory surplus of domestic
property and casualty insurers. This methodology is described in the Risk
Based Capital Model Act (the "RBC Model Act"). The RBC Model Act includes
a risk-based capital requirement that requires insurance companies to
calculate and report information under a risk-based formula which attempts
to measure statutory capital and surplus needs based on the risks in the
insurance company's mix of products and investment portfolio. The formula
is designed to allow state insurance regulators to identify potential
under-capitalized companies. Under the formula, an insurer determines its
"risk-based capital" ("RBC") by taking into account certain risks related
to the insurer's assets (including risks related to its investment
portfolio and ceded reinsurance) and the insurer's liabilities (including
underwriting risks related to the nature and experience of its insurance
business). The RBC rules provide for different levels of regulatory
attention depending on the ratio of a company's total adjusted capital to
its "authorized control level" of RBC. Insurers below the specific ratios
are classified within certain levels, each of which requires specific
corrective action. The levels and ratios are as follows:
Ratio of Total Adjusted Capital to
Authorized Control Level RBC
(Less than or equal to)
------------------------------------
Regulatory Event (1)
--------------------
Company Action Level (2) ...... 2.0
Regulatory Action Level (3) ... 1.5
Authorized Control Level (4) .. 1.0
Mandatory Control Level (5) ... 0.7
- ---------------------------
<FN>
(1) When an insurer's ratio exceeds 2.0, it is not subject to regulatory
attention under the RBC Model Act.
(2) "Company Action Level" requires an insurer to prepare and submit an RBC
Plan to the insurance commissioner of its state of domicile. After
review, the insurance commissioner will notify the insurer if the Plan
is satisfactory.
(3) "Regulatory Action Level" requires the insurer to submit an RBC Plan, or
if applicable, a Revised RBC Plan to the insurance commissioner of its
state of domicile. After examination or analysis, the insurance
commissioner will issue an order specifying corrective actions to be taken.
(4) "Authorized Control Level" authorizes the insurance commissioner to take
such regulatory actions considered necessary to protect the best interest
of the policyholders and creditors of an insurer which may include the
actions necessary to cause the insurer to be placed under regulatory
control (i.e., rehabilitation or liquidation).
(5) "Mandatory Control Level" authorizes the insurance commissioner to take
actions necessary to place the insurer under regulatory control (i.e.,
rehabilitation or liquidation).
PAGE 15
The ratios of total adjusted capital to authorized control level RBC for
NAICO were 5.2:1 and 5.7:1 at December 31, 2005 and 2006, respectively.
Therefore, NAICO's total adjusted capital exceeds the level that would trigger
regulatory attention pursuant to the risk-based capital requirement.
NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS-IRIS RATIOS
The National Association of Insurance Commissioners Insurance Regulatory
Information System ("IRIS") was developed by a committee of state insurance
regulators and is primarily intended to assist state insurance departments in
executing their statutory mandates to oversee the financial condition of
insurance companies operating in their respective states. IRIS identifies 13
industry ratios and specifies "usual values" for each ratio. Departure from
the "usual values," which fluctuate annually, on four or more ratios
generally leads to inquiries from individual state insurance commissioners.
NAICO had one 2006 ratio that was outside of the "usual values" as explained
below.
NAICO's "investment yield" as calculated using the IRIS formula was
10.3% during 2006 compared to a usual value of greater than 3.0% and less
than 6.5%. During 2006, NAICO recorded interest income of $6.6 million for
its estimate of prejudgment interest for a favorable jury verdict in civil
litigation regarding certain surety bond claims. Excluding this prejudgment
interest, NAICO's investment yield as calculated using the IRIS formula was
3.1%. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS" for more information. NAICO maintains a high-quality
investment portfolio, with no non-investment grade bonds, derivative
instruments or real estate investments (other than real estate occupied by
the company). NAICO's investment yield is largely dependent upon prevailing
levels of interest rates. The significant decline in interest rates in
recent years had a significant impact on NAICO's investment yield. Moreover,
in periods of relatively low interest rates, NAICO generally shortens
maturities and accepts lower yields to reduce market risk for future rate
increases.
EFFECT OF FEDERAL LEGISLATION
Although the Federal Government does not directly regulate the business
of insurance, federal initiatives often affect the insurance business in a
variety of ways. Current and proposed federal measures which may
significantly affect the insurance business include Federal Government
participation in asbestos and other product liability claims, claims related
to acts of terrorism, pension and other employee benefit plan regulation
(ERISA), examination of the taxation of insurers and reinsurers, minimum
levels of liability insurance and automobile safety regulations. Federal
regulation of the health care industry may directly and indirectly impact
the business of insurance.
ITEM 1A. RISK FACTORS.
Our business is subject to numerous risks and uncertainties, the outcome
of which may adversely impact future results of operations and financial
condition. The following risks, as well as other information included in
this 2006 Annual Report on Form 10-K, should be considered carefully.
IF OUR ACTUAL LOSSES EXCEED OUR LOSS RESERVES, OUR FINANCIAL RESULTS WOULD BE
ADVERSELY AFFECTED.
We maintain reserves for unpaid losses and loss adjustment expenses
which are estimates of the expense of investigation and settlement of all
reported and incurred but not reported losses under our previously issued
insurance policies and/or reinsurance contracts. These reserves do not
represent an exact measurement of liability, but are estimates based upon
historical data and anticipated future events. The process of estimating
loss reserves is complex and imprecise. We periodically review the reserve
estimates and the methods used to arrive at such reserve estimates, and we
also retain independent professional actuaries who review such reserve
estimates and methods. Any changes that result from these reviews are
reflected in current operating results.
If our estimates are incorrect and our reserves are inadequate, we are
required to increase our reserves. An increase in reserves results in an
increase in losses and a reduction in our net income for the period in which
the deficiency is identified. Accordingly, an increase in reserves could
have a material adverse effect on our results of operations, liquidity and
financial condition.
CATASTROPHIC EVENTS AND ACTS OF TERRORISM CAN HAVE A SIGNIFICANT IMPACT ON
OUR RESULTS OF OPERATIONS, LIQUIDITY AND FINANCIAL CONDITION.
We are subject to claims arising out of catastrophes that may have a
significant effect on our results of operations, liquidity and financial
condition. Catastrophes can be caused by various events, including
tornadoes, windstorms, hail, fires, severe winter weather, earthquakes,
power outages and explosions, and may include man-made events such as
terrorist attacks. The frequency and severity of these catastrophes are
inherently unpredictable. The extent of losses from a catastrophe is a
function of both the total amount of insured exposure in the area affected
by the event and the severity of the event.
PAGE 16
We seek to reduce the impact of a catastrophe on our business through
the purchase of catastrophe and terrorism reinsurance. Reinsurance does not
relieve us of our direct liability to our policyholders. As long as the
reinsurers meet their obligations, our net liability is limited to the amount
of risk that we retain. Reinsurance, however, may prove inadequate if a
major catastrophic loss exceeds the reinsurance limit or the reinsurers'
financial capacity.
OUR RESULTS MAY FLUCTUATE BASED ON MANY FACTORS, INCLUDING CYCLICAL CHANGES
IN THE INSURANCE INDUSTRY.
The results of companies in the property and casualty insurance industry
historically have been subject to significant fluctuations and uncertainties.
The industry's profitability can be affected significantly by rising levels
of claim costs that are not known by companies at the time they price their
products. The property and casualty insurance industry historically is
cyclical. The demand for property and casualty insurance can vary
significantly, generally rising as the overall level of economic activity
increases and falling as such activity decreases. The property and casualty
insurance industry also has been very competitive. During the late 1990's
and into 2000, property and casualty insurance companies generally under
priced their products, which resulted in poor underwriting results that were
partially offset by investment returns. Interest rates decreased in 2000 and
underwriting results continued to deteriorate for business written in the
late 1990's and into 2000. These factors coupled with additional potential
losses due to terrorism and lower investment returns caused the industry to
increase pricing beginning in the latter half of 2001. Rate increases
continued through 2003 and to a lesser extent in 2004, and the industry's
underwriting results have improved. The pricing environment during 2005 and
2006 experienced downward pressure, particularly for larger accounts. The
recent industry trend has been for insurers to maintain or reduce rate
levels, and NAICO has reduced its pricing in certain situations and for certain
coverages including workers compensation during 2006. The hurricane activity
during the third quarter of 2005 may result in higher rates for certain
property business. Reinsurance costs may increase substantially. Competition
for profitable business in the past has resulted in pressure on pricing and
less restrictive terms and conditions, contributing to the cyclical pricing
and underwriting results.
Our underwriting philosophy is to forego underwriting risks from which
we are unable to obtain what we believe to be adequate premium rates.
However, the fluctuations in demand and competition and the impact on us of
other factors described above could have a material adverse effect on our
business, results of operations and/or financial condition.
OUR ABILITY TO REDUCE OUR EXPOSURE TO RISKS DEPENDS ON THE AVAILABILITY AND
COST OF REINSURANCE.
We transfer a portion of our risks insured under our policies and
reinsurance contracts to other companies through reinsurance arrangements.
These reinsurance arrangements reduce the potential impact of unusually
severe or frequent losses. The amount and cost of reinsurance are subject,
in large part, to prevailing market conditions that are beyond our control.
Our ability to provide insurance at competitive premium rates and coverage
limits on a continuing basis depends to a great extent upon our ability to
obtain adequate reinsurance in amounts and at rates that will not adversely
affect our competitive position. If we are unable to maintain such
arrangements, then we would be forced to either bear the associated increase
in net exposures or reduce the amount of risk that we underwrite. Either of
these circumstances could have a material adverse effect on our results of
operations, liquidity and/or financial condition.
IF WE ARE UNABLE TO COLLECT FROM OUR REINSURERS ON A TIMELY BASIS, OUR
FINANCIAL RESULTS WOULD BE ADVERSELY AFFECTED.
We face a credit risk when we obtain reinsurance because we are still
liable for the transferred risks if the reinsurer cannot meet the transferred
obligations. Losses may not be recovered from our reinsurers until claims
are paid and, in the case of certain long-term workers compensation and
liability claims, the credit worthiness of our reinsurers may change before
we can recover amounts to which we are entitled. The failure of any of our
reinsurers to pay reinsurance claims on a timely basis could have a material
adverse effect on our results of operations, liquidity and financial condition.
THE FAIR VALUE OF OUR INVESTMENT PORTFOLIO AND OUR INVESTMENT INCOME COULD
SUFFER AS A RESULT OF FLUCTUATIONS IN INTEREST RATES AND MARKET CONDITIONS.
Our market risk generally represents the risk of gain or loss that may
result from the potential change in the fair value of our investment portfolio
as a result of fluctuations in prices and interest rates. A portion of our
interest expense fluctuates with changes in interest rates as well.
Increases and decreases in prevailing interest rates generally translate
into decreases and increases in fair values of those instruments.
Additionally, fair values of interest rate sensitive instruments may be
affected by the credit worthiness of the issuer, prepayment options, relative
values of alternative investments, liquidity of the instrument and other
general market conditions. Any significant decline in our investment income
as a result of falling interest rates, decreased dividend payment rates or
general market conditions would have an adverse effect on our results. Any
significant decline in the market value of our investments would reduce our
shareholder's equity and our policyholders' surplus, which could impact our
ability to write additional business.
PAGE 17
WE MAY BE ADVERSELY IMPACTED BY A CHANGE IN OUR FINANCIAL STRENGTH RATING.
Insurance companies are subject to financial strength ratings produced
by external rating agencies. Higher ratings generally indicate greater
financial stability and a stronger ability to pay claims. Ratings are
assigned by rating agencies to insurers based upon factors they believe are
important to policyholders. Ratings are not recommendations to buy our
securities.
NAICO's ability to write business is most influenced by our rating
from A.M. Best Company. A.M Best ratings are designed to assess an
insurer's financial strength and ability to meet continuing obligations to
policyholders. Currently, our rating from A.M. Best is "B+" (Very Good),
with a negative outlook. A negative outlook is placed on a company's
rating if it is experiencing unfavorable financial or market trends, and
if continued, the company has a good possibility of having its rating
downgraded. NAICO's rating and outlook were downgraded to the current
rating from "B++" effective June 21, 2005. The downgrade was primarily due
to the significant net loss and decline in statutory surplus in 2004 which
were driven by adverse loss reserve development on prior accident years. We
believe that as a result of our improved surplus and operating performance
in 2005 and 2006, our rating will remain at least at its current level.
However, there can be no assurance that A.M. Best will not change its rating
in the future. A rating downgrade from A.M. Best could adversely affect the
business we write and our results of operations.
WE DEPEND ON OUR INDEPENDENT INSURANCE AGENTS.
We market and sell our insurance products through independent,
non-exclusive insurance agencies. These agencies are not obligated to sell
our insurance products, and generally they also sell our competitors'
insurance products. As a result, our business depends in part on the
marketing and sales efforts of these agencies. If we diversify and expand
our business geographically, then we may need to expand our network of
agencies to successfully market our products. If these agencies fail to
market our products successfully, our business may be adversely impacted.
Also, independent agents may decide to sell their businesses to banks,
other insurance agencies or other businesses. Changes in ownership of
agencies, or expansion of agencies through acquisition, could adversely
affect an agency's ability to control growth and profitability, thereby
adversely affecting our business.
MUCH OF OUR BUSINESS IS CONCENTRATED IN THE SOUTHWEST AND MIDWEST AREAS OF
THE UNITED STATES, WHICH TIES OUR PERFORMANCE TO THE ENVIRONMENTAL,
BUSINESS, ECONOMIC AND REGULATORY CONDITIONS OF THESE REGIONS.
During 2006, approximately 76% of our written premiums were in the
states of Oklahoma and Texas. Unusually severe storms or other natural or
man-made disasters that destroy property in these states could adversely
affect our operations. Our revenues and profitability are also subject to
prevailing economic and regulatory conditions in these states. An economic
downturn in these states could have a significant adverse impact on our
business. The loss of a significant amount of premiums written in either
of these states, whether due to regulatory changes, competitive changes,
economic downturns in these states or other reasons, would reduce our
revenues and could have a material adverse effect on our results of
operations, liquidity and/or financial condition.
WE OPERATE IN A HIGHLY COMPETITIVE INDUSTRY.
We compete with local, regional and national insurance companies in our
selected lines of business. Many of these companies are larger, have
greater financial, marketing and management resources, have more favorable
ratings by ratings agencies and offer more diversified insurance coverages
than we do. In addition, we face competition within each insurance agency
that sells our insurance because we sell through independent agencies that
represent more than one insurance company.
The property and casualty insurance industry is highly competitive on
the basis of product, price and service. If our competitors offer products
with more coverage, or price their products more aggressively, our ability
to grow or renew our business may be adversely impacted. The inability to
compete effectively could materially reduce our customer base and revenues,
and could adversely affect our results of operations, liquidity and
financial condition.
WE ARE AN INSURANCE HOLDING COMPANY WITH NO DIRECT OPERATIONS, WHICH COULD
ADVERSELY AFFECT OUR ABILITY TO MEET OUR DEBT OBLIGATIONS.
As a holding company with no business operations of its own, we receive
cash principally through borrowings, subsidiary dividends and other payments
from our subsidiaries and parent company to pay interest on and repay the
principal of our debt. Statutes and regulations governing NAICO and other
insurance companies domiciled in Oklahoma regulate the payment of shareholder
dividends and other payments from NAICO to Chandler USA. To the extent that
these restrictions limit NAICO's ability to pay dividends or other payments
to us, our ability to satisfy our obligations may also be limited.
PAGE 18
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.
WE ARE HEAVILY REGULATED IN THE STATES IN WHICH WE OPERATE.
NAICO is subject to regulation by government agencies in the
jurisdictions in which it does business. The nature and extent of such
regulation vary from jurisdiction to jurisdiction, but typically involve
prior approval of the acquisition of control of an insurance company or of
any company controlling an insurance company, regulation of certain
transactions entered into by an insurance company with any of its
affiliates, approval of premium rates, forms and policies used for many
lines of insurance, standards of solvency and minimum amounts of capital
and surplus which must be maintained, establishment of reserves required
to be maintained for unearned premiums, unpaid losses and loss adjustment
expenses or for other purposes, limitations on types and amounts of
investments, restrictions on the size of risks which may be insured by a
single company, licensing of insurers and agents, deposits of securities
for the benefit of policyholders and the filing of periodic reports with
respect to financial condition and other matters. In addition, regulatory
examiners perform periodic financial and market conduct examinations of
insurance companies. Such regulation is generally intended for the
protection of policyholders rather than shareholders or creditors.
NAICO is also affected by a variety of state and federal legislative
and regulatory measures and judicial decisions that define and extend the
risks and benefits for which insurance is sought and provided. These
include redefinitions of risk exposure in areas such as product liability,
environmental damage and workers compensation. In addition, individual
state insurance departments may prevent premium rates for some classes of
insureds from reflecting the level of risk assumed by the insurer for those
classes. Such developments may adversely affect the profitability of
various lines of insurance. In some cases, these adverse effects on
profitability can be minimized through re-pricing, if permitted by
applicable regulations, of coverages or limitations or cessation of the
affected business.
This extensive regulation of our business may affect the cost or demand
for our products and may limit our ability to obtain rate increases or to
take other actions that we might desire to increase our profitability. In
addition, we may be unable to maintain all required approvals or comply
fully with the wide variety of applicable laws and regulations, or the
relevant authority's interpretation of such laws and regulations.
LITIGATION AND LEGAL PROCEEDINGS AGAINST US COULD HAVE AN ADVERSE EFFECT ON
OUR BUSINESS, RESULTS OF OPERATIONS AND/OR FINANCIAL CONDITION.
Like other insurance companies, we are involved in lawsuits and legal
proceedings in the normal course of our business, some of which involve
claims for substantial amounts and the outcomes of which are unpredictable.
This litigation is based on a variety of issues including insurance and
claim settlement practices.
ASSESSMENTS FOR GUARANTY FUNDS AND OTHER MANDATORY POOLING ARRANGEMENTS MAY
REDUCE OUR PROFITABILITY.
Virtually all states require insurers licensed to do business in their
state to bear a portion of the loss suffered by some insureds as the result
of impaired or insolvent insurance companies. These obligations are funded
by assessments that are expected to continue in the future as a result of
insolvencies. In addition, as a condition to the ability to conduct
business in some states, insurance companies are required to participate in
mandatory workers compensation shared market mechanisms or pooling
arrangements, which provide workers compensation insurance coverage from
private insurers. The effect of these assessments and mandatory shared
market mechanism or changes in them could reduce our profitability in any
given period or limit our ability to grow our business.
WE DEPEND ON KEY PERSONNEL.
We believe that our future success will depend to a significant extent
on our ability to attract and retain key employees, in particular our senior
officers, and key management, information systems, underwriting, claims and
corporate personnel.
PAGE 19
MANAGING TECHNOLOGY INITIATIVES AND MEETING NEW DATA SECURITY REQUIREMENTS
PRESENT SIGNIFICANT CHALLENGES.
While technological developments can streamline many business processes
and ultimately reduce the cost of operations, technology initiatives can
present short term cost and implementation risks. Data security is subject
to increasing regulation. We face rising costs and competing time
constraints in meeting compliance requirements of new and proposed
regulations. The expanding volume and sophistication of computer viruses,
hackers and other external hazards may increase the vulnerability of our
data systems to security breaches. These increased risks and expanding
regulatory requirements expose us to potential data loss and damages and
significant increases in compliance costs.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
Not applicable.
ITEM 2. PROPERTIES.
Chandler USA and its subsidiaries own and occupy four office buildings
with approximately 127,000 square feet of usable space in Chandler, Oklahoma.
Chandler USA believes such space is sufficient for its operations for the
foreseeable future.
ITEM 3. LEGAL PROCEEDINGS.
See Note 10 to Consolidated Financial Statements for a discussion of
litigation matters.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the
quarter ended December 31, 2006.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES.
All of the common stock of Chandler USA, its sole class of common
equity on the date hereof, is owned by Chandler Insurance. Chandler USA
has never paid cash dividends on its common shares.
ITEM 6. SELECTED FINANCIAL DATA.
The selected financial data has been derived from the consolidated
financial statements of Chandler USA and its subsidiaries, which appear
in Item 15(a). The consolidated balance sheets of Chandler USA and its
subsidiaries and the related consolidated statements of operations,
comprehensive income, shareholder's equity and cash flows for each of the
five years in the period ended December 31, 2006 have been audited by
Tullius Taylor Sartain & Sartain LLP, independent auditors, whose
independent auditors' report expresses an unqualified opinion. The
selected financial data should be read in conjunction with "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS"
and the consolidated financial statements of Chandler USA and the notes
thereto appearing in Item 15(a). Amounts for 2002 have been restated to
reflect the results of LaGere & Walkingstick Insurance Agency, Inc.
("L&W") as a discontinued operation.
PAGE 20
ITEM 6. SELECTED FINANCIAL DATA (CONTINUED).
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
2002 2003 2004 2005 2006
--------- --------- --------- --------- ---------
(Dollars in thousands)
OPERATING DATA (1)
Revenues
Direct premiums written and assumed ............. $140,162 $118,444 $121,651 $120,344 $113,043
========= ========= ========= ========= =========
Net premiums earned ............................. $ 66,957 $ 56,583 $ 64,042 $ 66,060 $ 65,704
Investment income, net (2) ...................... 2,540 2,148 3,186 2,798 9,801
Interest income, net from related parties ....... 380 412 491 670 792
Realized investment gains, net .................. 794 2,351 652 383 745
Other income (3) ................................ 261 5,077 640 251 317
--------- --------- --------- --------- ---------
Total revenues ..................................... 70,932 66,571 69,011 70,162 77,359
--------- --------- --------- --------- ---------
Operating expenses
Losses and loss adjustment expenses ............. 50,712 37,200 53,781 37,324 45,473
Policy acquisition costs ........................ 10,239 11,278 11,039 10,671 11,666
General and administrative expenses ............. 12,473 13,486 12,380 12,749 12,469
Interest expense ................................ 2,234 2,441 2,397 2,535 2,690
--------- --------- --------- --------- ---------
Total operating expenses ........................... 75,658 64,405 79,597 63,279 72,298
--------- --------- --------- --------- ---------
Income (loss) from continuing operations before
income taxes .................................... (4,726) 2,166 (10,586) 6,883 5,061
Federal income tax benefit (provision) ............. 1,680 (192) 3,582 (2,450) (1,665)
--------- --------- --------- --------- ---------
Income (loss) from continuing operations ........... (3,046) 1,974 (7,004) 4,433 3,396
Income (loss) from discontinued operations ......... 284 - - - -
Gain on sale of subsidiary ......................... 671 - - - -
--------- --------- --------- --------- ---------
Net income (loss) .................................. $ (2,091) $ 1,974 $ (7,004) $ 4,433 $ 3,396
========= ========= ========= ========= =========
Combined loss and underwriting expense ratio (4) ... 110% 113% 118% 92% 106%
BALANCE SHEET DATA
Cash and investments ............................... $ 68,276 $ 69,198 $ 86,913 $ 86,316 $ 89,703
Amounts due from related parties ................... 10,582 9,642 10,891 9,360 9,584
Total assets ....................................... 229,855 218,213 237,297 245,059 222,772
Unpaid losses and loss adjustment expenses ......... 92,606 87,768 108,233 109,541 83,253
Debentures ......................................... 24,000 7,254 6,979 6,979 6,979
Junior subordinated debentures issued to affiliated
trusts .......................................... - 20,620 20,620 20,620 20,620
Total liabilities .................................. 186,855 174,374 201,105 205,373 179,808
Shareholder's equity ............................... 43,000 43,839 36,192 39,686 42,964
- ------------------------------------------------------
<FN>
(1) In December 2002, Chandler USA completed the sale of a wholly owned subsidiary for $3.6 million.
Chandler USA recorded an after-tax gain of $671,000 on the sale in 2002 based on the minimum purchase
price for the transaction. Amounts for 2002 have been restated to reflect the results of the subsidiary
as a discontinued operation.
(2) Net investment income included $577,000 in interest from an arbitration award in 2004, and $6.6 million
for the accrual of prejudgment interest on a favorable jury verdict in 2006. For additional information,
see "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS."
(3) Other income included a $3.1 million gain on the purchase and cancellation of $16.7 million principal
amount of Debentures in 2003, and $1.7 million and $368,000 for the amortization of the deferred gain on
a sale and leaseback transaction in 2003 and 2004, respectively.
(4) Interest expense and certain litigation expenses are not considered underwriting expenses and have
been excluded from this ratio.
PAGE 21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
GENERAL
References to Chandler USA which follow within this Item 7 refer to
Chandler USA and its subsidiaries on a consolidated basis unless otherwise
indicated.
Chandler USA is engaged in various property and casualty insurance
operations through its wholly owned subsidiaries, NAICO and CIMI. NAICO
writes various property and casualty insurance products through two separate
marketing programs: standard lines and political subdivisions. The lines of
insurance written by NAICO are commercial coverages consisting of workers
compensation, automobile liability, other liability (including general
liability, products liability and umbrella liability), automobile physical
damage, property, surety and inland marine. During 2005, NAICO began writing
homeowner and dwelling fire and allied lines policies in the state of Texas
through a managing general agent. NAICO discontinued its homeowners program
during 2006, and has also transferred its property and inland marine business
for the standard lines and political subdivisions programs to Praetorian
effective January 1, 2007 through a new arrangement between Praetorian and
CIMI. See "Insurance Programs" for more information. NAICO markets these
products through a network of independent insurance agents. A portion of the
insurance written by NAICO is reinsured by Chandler USA's parent Chandler
Insurance. CIMI is an underwriting manager and wholesaler that offers
multiple insurance products for businesses in various industries and
political subdivisions.
SUMMARY OF RESULTS
For the year ended December 31, 2006, Chandler USA had net income of
$3.4 million compared to net income of $4.4 million for 2005 and a net loss
of $7.0 million for 2004. The net loss in 2004 is primarily due to the
adverse loss development experienced by NAICO. See "Losses and Loss
Adjustment Expenses."
Many factors determine the profitability of an insurance company
including regulation and rate competition; the frequency and severity of
claims; the cost, availability and collectibility of reinsurance; interest
rates; inflation; general business conditions; and jury awards, court
decisions and legislation expanding the extent of coverage and the amount
of compensation due for injuries and losses.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with U.S. GAAP
requires the application of accounting policies that often involve a
significant degree of judgment. Management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the periods. If management determines, as a result of its
consideration of facts and circumstances, that changes in estimates and
assumptions are appropriate, results of operations and financial position as
reported in the consolidated financial statements may change significantly.
Management has identified the following accounting policies as critical in
understanding Chandler USA's reported financial results.
RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
Insurance companies provide in their financial statements reserves for
unpaid losses and loss adjustment expenses which are estimates of the
expense of investigation and settlement of all reported and incurred but not
reported losses under their previously issued insurance policies and
reinsurance contracts. In estimating reserves, insurance companies use
various standardized methods based on historical experience and payment and
reporting patterns for the type of risk involved. The application of these
methods necessarily involves subjective determinations by the personnel of
the insurance company. Inherent in the estimates of the ultimate liability
for unpaid claims are expected trends in claim severity, claim frequency and
other factors that may vary as claims are settled. The amount of and
uncertainty in the estimates is affected by such factors as the amount of
historical claims experience relative to the development period for the type
of risk, knowledge of the actual facts and circumstances, and the amount of
insurance risk retained. The ultimate cost of insurance claims can be
adversely affected by increased costs, such as medical expenses, repair
expenses, costs of providing legal defense for policyholders, increased jury
awards and court decisions and legislation that expand insurance coverage
after the insurance policy was priced and sold. In recent years, certain of
these factors have contributed to incurred amounts that were significantly
higher than original estimates. Accordingly, the loss and loss adjustment
expense reserves may not accurately predict an insurance company's ultimate
liability for unpaid claims.
PAGE 22
Estimating the ultimate loss and loss adjustment expense liability is a
complex and judgmental process inasmuch as the amounts are based on
management's informed estimates, assumptions and judgments using data
currently available. The assumptions used in establishing reserves are
regularly reviewed and updated by management as new data becomes available.
Changes to estimates of previously established reserves are included in
earnings in the period in which the estimate is changed. Such changes in
estimates may be material. If the ultimate losses prove to differ
substantially from the amounts previously recorded, the related adjustments
could have a material adverse effect on Chandler USA's financial condition,
results of operations and liquidity.
NAICO's loss reserves consist of case reserves and reserves for incurred
but not reported ("IBNR") claims. Case reserves are established by claims
personnel based on a review of the facts known at the time the claim is
reported, and are subsequently revised as more information about a claim
becomes known. IBNR is computed using various actuarial methods and
techniques and includes reserves for losses that have occurred but for which
claims have not yet been reported, including provision for expected future
development on case reserves. As of December 31, 2006, NAICO's case reserves
and IBNR for each line of business are shown in the following table.
Gross reserves at December 31, 2006 Net reserves at December 31, 2006
----------------------------------- ---------------------------------
Case Total Case Total
reserves IBNR reserves reserves IBNR reserves
----------- ----------- ----------- ---------- ---------- -----------
(In thousands) (In thousands)
Other liability ............... $ 10,716 $ 33,882 $ 44,598 $ 5,055 $ 10,564 $ 15,619
Automobile liability .......... 15,363 19,015 34,378 10,942 12,912 23,854
Workers compensation .......... 20,155 17,304 37,459 8,517 7,172 15,689
Automobile physical damage .... 371 - 371 263 - 263
Property ...................... 929 87 1,016 458 64 522
Surety ........................ (34,514) 221 (34,293) (13,637) 91 (13,546)
Accident and health ........... (336) - (336) (337) - (337)
Inland marine ................. 60 - 60 17 - 17
----------- ----------- ----------- ---------- ---------- -----------
Total reserves .............. $ 12,744 $ 70,509 $ 83,253 $ 11,278 $ 30,803 $ 42,081
=========== =========== =========== ========== ========== ===========
NAICO periodically reviews the reserve estimates relating to insurance
business written or assumed by NAICO and the methods used to arrive at such
reserve estimates. NAICO also retains independent professional actuaries
who review such reserve estimates and methods. Methods used include the
paid loss development method, incurred loss development method,
Bornhuetter-Ferguson method and loss ratio method. Most methods assume
that past patterns in the historical data will be repeated in the future,
as long as there are no significant changes in pertinent variables. The
methods chosen are those that are believed to produce the most reliable
indication at that particular evaluation date. While each of the methods
produce point estimates for each period analyzed, management's best estimate
is usually comprised of a combination of methods due to differences in
conditions during each period. The selected estimate may be one method, or
a weighted average of several methods, or a judgmental selection if management
determines it is appropriate. The ultimate point estimate selected by
management represents the amount that management believes is the most likely
amount that will ultimately be paid to settle the net reserves recorded at a
particular point in time.
Reserves for losses and loss adjustment expenses are developed using
multiple estimation methods that result in various point estimates for each
insurance program. The estimate recorded by management is a function of
detailed analysis of the historical trends and development factors resulting
from the different methods. As a result of the variety of factors that must
be considered by management there is a significant risk that actual incurred
losses will develop differently from these estimates.
The process of selecting the point estimate from the set of possible
outcomes produced by the various actuarial methods discussed above is based
upon the judgment of management. In making its selection, management
considers recent trends in claims frequency and severity and other factors
including, but not limited to, large loss activity, large case reserve
additions, historical loss information, per claim information, NAICO's loss
retention, legislative enactments, judicial decisions, and trends in general
economic conditions, including the effects of inflation. This process
assumes that past experience, adjusted for the effects of current
developments and anticipated trends, is an appropriate basis for predicting
future events. Significant changes in claims development patterns from
historical claims development patterns may cause a significant variation
between current reserve estimates and the actual future paid amounts.
Assumptions used in establishing loss reserves are regularly reviewed and
updated by management as new data becomes available. The changes in these
estimates, resulting from the review process and the differences between
estimates and ultimate payments, are reflected in the consolidated statements
of operations for the period in which such estimates are changed. Such
changes in estimates may be material. See Notes to Consolidated Financial
Statements.
PAGE 23
The following table shows the recorded reserves and the high and low
point estimates based on the results of the various actuarial methods
described above as of December 31, 2006.
Insurance program Low High Recorded
------------------------------------------- --------- ---------- -----------
(In thousands)
Gross Reserves
--------------
Standard lines ........................... $ 86,080 $ 144,741 $ 103,904
Political subdivisions ................... 4,320 4,320 4,320
Homeowners ............................... 559 559 559
Surety bonds ............................. (34,289) (34,289) (34,289)
Involuntary workers compensation pools ... 5,898 5,898 5,898
Other .................................... 2,861 2,861 2,861
--------- ---------- -----------
$ 65,429 $ 124,090 $ 83,253
========= ========== ===========
Net Reserves
------------
Standard lines ........................... $ 34,645 $ 69,910 $ 44,522
Political subdivisions ................... 2,130 2,440 2,082
Homeowners ............................... 419 419 419
Surety bonds ............................. (13,542) (13,542) (13,542)
Involuntary workers compensation pools ... 5,898 5,898 5,898
Other .................................... 2,702 2,702 2,702
--------- ---------- -----------
$ 32,252 $ 67,827 $ 42,081
========= ========== ===========
)
For the standard lines program, NAICO's actuaries selected the
results of the incurred loss development method for the 2004 and prior
accident years. The 2005 and 2006 accident years were based on
judgmentally selected loss ratios in order to adjust for the effect of
case reserve strengthening that was recorded during these years. The
estimation methods chosen are those that are believed to produce the most
reliable indication at that particular evaluation date for the losses
being evaluated. The point estimates for the political subdivisions,
homeowners and surety bond programs are less volatile as portions of
these programs are in a run-off mode and can be estimated with more
certainty. Surety bond reserves are actually a net receivable due to
anticipated subrogation recoveries. Certain involuntary pools provided
their own estimates and NAICO records these estimates plus an accrual to
account for the lag time in reporting to NAICO. The actuarial methods used
in the 2006 loss reserve analysis were similar to those used in the 2005
analysis.
The loss settlement period on insurance claims for property damage is
relatively short. The more severe losses for bodily injury, workers
compensation and other liability claims have a much longer loss settlement
period and may be paid out over several years. It is often necessary to
adjust estimates of liability on a loss either upward or downward between
the time a claim arises and the time of payment. Workers compensation
indemnity benefit reserves are determined based on statutory benefits
prescribed by state law and are estimated based on the same factors
generally discussed above which may include, where state law permits,
inflation adjustments for rising benefits over time. Generally, the more
costly automobile liability claims involve one or more severe bodily
injuries or deaths. Other liability claims include coverages protecting
the insured against legal liability resulting from negligence,
carelessness, or a failure to act causing property damage or personal
injury to others. The estimation of loss reserves for other liability
claims is affected by the timing of claims reporting, the applicable
statute of limitations, the litigious climate and magnitude of jury awards,
the unpredictability of judicial decisions regarding coverage issues and
outside counsel costs. The ultimate cost of these types of claims is
dependent on various factors including the relative liability of the
parties involved, the number and severity of injuries and the legal
jurisdiction where the incident occurred.
NAICO does not ordinarily insure against environmental matters as that
term is commonly used. However, in some cases, regulatory filings made on
behalf of an insured can make NAICO directly liable to the regulatory
authority for property damage, which could include environmental pollution.
In those cases, NAICO ordinarily has recourse against the insured or the
surety bond principal for amounts paid. NAICO has insured certain trucking
companies and pest control operators who are required to provide proof of
insurance which in some cases assures payment for cleanup and restoration
of damage resulting from sudden and accidental release or discharge of
contaminants or other substances which may be classified as pollutants.
NAICO also provides surety bonds for construction contractors who use or
have control of such substances and for contractors who remove and dispose
of asbestos as a part of their contractual obligations.
NAICO also insures independent oil and gas producers who may purchase
coverage for the escape of oil, saltwater, or other substances which may be
harmful to persons or property, but may not generally be classified as
pollutants. NAICO maintains claims records which segregate this type of
risk for the purpose of evaluating environmental risk exposure. Based upon
the nature of such lines of business with NAICO's insureds, and current
data regarding the limited severity and infrequency of such matters, it
appears that potential environmental risks are not a significant portion of
claim reserves and therefore would not likely have a material adverse
impact, if any, on the financial condition of Chandler USA.
NAICO's statutory-based reserves (reserves calculated in accordance with
accounting practices prescribed or permitted by an insurer's domiciliary
state insurance regulatory authorities for purposes of financial reporting
to regulators) do not differ from its reserves reported on the basis of
GAAP. NAICO does not discount its reserves for unpaid losses and loss
adjustment expenses.
PAGE 24
Management believes that its unpaid losses and related reinsurance
recoverables are fairly stated as of December 31, 2006. However, estimating
the ultimate claims liability is necessarily a complex and judgmental process
inasmuch as the amounts are based on management's informed estimates,
assumptions and judgments using data currently available.
REINSURANCE RECOVERABLES
Reinsurance recoverables on unpaid losses and loss adjustment expenses
are similarly subject to changes in estimates and assumptions. Amounts
recoverable from reinsurers are estimated in a manner consistent with the
claim liability associated with the reinsured policies. In addition to
factors noted above, estimates of reinsurance recoverables may prove
uncollectible if the reinsurer is unable or unwilling to meet its
responsibilities under the reinsurance contracts. Reinsurance contracts do
not relieve an insurer from its obligation to policyholders.
DEFERRED INCOME TAXES
Chandler USA uses an asset and liability approach for accounting for
income taxes. Deferred income taxes are recognized for the tax consequences
of temporary differences and carryforwards by applying enacted tax rates
applicable to future years to differences between the financial statement
amounts and the tax bases of existing assets and liabilities. A valuation
allowance is established if it is more likely than not that some portion
of the deferred tax asset will not be realized. The determination of
whether a valuation allowance is appropriate requires the exercise of
management judgment.
At December 31, 2006, Chandler USA had a net operating loss carryforward
available for U.S. Federal income taxes of $4.6 million which begins to
expire in 2024. Chandler USA has concluded that the deferred tax asset
including the federal net operating loss carryforwards is more likely than
not to be realized. Chandler USA anticipates that its future U.S.
consolidated income will be sufficient to utilize the federal net operating
losses within the required time. Chandler USA will continue to evaluate
income generated in future periods in determining the reasonableness of its
position. If Chandler USA determines that future income is insufficient to
cause the realization of the federal net operating losses within the
required time, a valuation allowance will be established.
In addition, Chandler USA, at December 31, 2006, had net operating
loss carryforwards available for Oklahoma state income taxes totaling
approximately $53.8 million which expire in the years 2007 through 2026.
At December 31, 2006, Chandler USA also had a capital loss carryforward for
U.S. Federal income taxes of $2.4 million which expires in 2007. A
valuation allowance has been provided for the tax effect of the state net
operating loss and the net capital loss carryforwards since realization of
such amounts is not considered more likely than not.
OTHER
See Note 1 to Consolidated Financial Statements for information related
to other accounting and reporting policies.
ECONOMIC CONDITIONS
The impact of a recession on Chandler USA would depend on its duration
and severity. A prolonged downturn in the economy could result in decreased
demand for NAICO's insurance products and an increase in uncollectible
premiums and/or reinsurance recoverables. In addition, an economic downturn
could result in an increase in the number of insurance claims if insureds
decrease expenditures that promote safety. Much of NAICO's insurance
business is concentrated in the Southwest and Midwest areas of the United
States. Approximately $86.4 million, or 76%, of NAICO's direct written and
assumed premiums in 2006 were in the states of Oklahoma and Texas. An
economic downturn in these states could have a significant adverse impact
on Chandler USA. A recession might also cause defaults on fixed-income
securities or a decrease in the value of the equity mutual funds owned by
NAICO. Management believes it has mitigated the impact of a recession by
employing conservative underwriting practices and strict credit policies
and maintaining a high-quality investment portfolio.
Periods of inflation have varying effects on Chandler USA and its
subsidiaries as well as other companies in the insurance industry.
Inflation contributes to higher claims and related costs and operating
costs as well as higher interest rates which generally provide for
potentially higher interest rates on investable cash flow and decreases
in the market value of existing fixed-income securities. Premium rates
and commissions, however, are not significantly affected by inflation since
competitive forces generally control such rates.
PAGE 25
COMPETITION
NAICO operates in a highly competitive industry and faces competition
from domestic and foreign insurers, many of which are larger, have greater
financial, marketing and management resources, have more favorable ratings
by ratings agencies and offer more diversified insurance coverages than NAICO.
An insurance company's capacity to write insurance policies is dependent
on a variety of factors including its net worth or "surplus," the lines of
business written, the types of risk insured and its profitability. During
the late 1990's and into 2000, property and casualty insurance companies
generally under priced their products, which resulted in poor underwriting
results that were partially offset by investment returns. Interest rates
decreased in 2000 and underwriting results continued to deteriorate for
business written in the late 1990's and into 2000. These factors coupled
with additional potential losses due to terrorism and lower investment
returns caused the industry to increase pricing beginning in the latter
half of 2001. Rate increases continued through 2003 and to a lesser extent
in 2004, and the industry's underwriting results have improved. The pricing
environment during 2005 and 2006 experienced downward pressure, particularly
for larger accounts. NAICO was able to increase its pricing for most
coverages from 2001 through 2005. However, the recent industry trend has
been for insurers to maintain or reduce rate levels, and NAICO has reduced
its pricing in certain situations and for certain coverages including
workers compensation during 2006. NAICO continues to experience competition
in all of its programs. NAICO's underwriting philosophy is to forego
underwriting risks from which it is unable to obtain what it believes to
be adequate premium rates.
REGULATION
NAICO is subject to regulation by government agencies in the
jurisdictions in which it does business. The nature and extent of such
regulations vary from jurisdiction to jurisdiction, but typically involve
prior approval of the acquisition of control of an insurance company or of
any company controlling an insurance company, regulation of certain
transactions entered into by an insurance company with any of its
affiliates, approval of premium rates, forms and policies used for many
lines of insurance, standards of solvency and minimum amounts of capital
and surplus which must be maintained, establishment of reserves required
to be maintained for unearned premiums, unpaid losses and loss adjustment
expenses or for other purposes, limitations on types and amounts of
investments, restrictions on the size of risks which may be insured by a
single company, licensing of insurers and agents, deposits of securities
for the benefit of policyholders and the filing of periodic reports with
respect to financial condition and other matters. In addition, regulatory
examiners perform periodic examinations of insurance companies. Such
regulation is generally intended for the protection of policyholders
rather than shareholders or creditors.
As an Oklahoma corporation, NAICO and any person controlling NAICO,
directly or indirectly, are subject to the insurance laws of Oklahoma
including laws concerning the change or acquisition of control and payment
of shareholder and policyholder dividends by NAICO.
In addition to the regulatory oversight of NAICO, Chandler Insurance
is also subject to regulation under the laws of the Cayman Islands and
Chandler USA and all of its affiliates are also subject to regulation
under the Oklahoma Insurance Code. The Oklahoma Insurance Code contains
certain reporting requirements including those requiring Chandler
Insurance, as the ultimate parent company, to file information relating
to its capital structure, ownership and financial condition and general
business operations of its insurance subsidiaries. The Oklahoma Insurance
Code contains special reporting and prior approval requirements with
respect to transactions among affiliates. The Oklahoma Insurance Code
also imposes certain requirements upon any person controlling or seeking
to control an insurance company domiciled in Oklahoma. Control is
generally presumed to exist if any person, directly or indirectly, owns,
controls, holds with the power to vote or holds proxies representing 10%
or more of the voting securities of the insurance company or of any other
person or entity controlling the insurance company. The 10% presumption
is not conclusive and control may be found to exist at less than 10%.
Persons owning any securities of Chandler USA or Chandler Insurance must
comply with the Oklahoma Insurance Code. See "BUSINESS - Regulation."
Insurance companies are also affected by a variety of state and
federal legislative and regulatory measures and judicial decisions that
define and extend the risks and benefits for which insurance is sought and
provided. These include the redefinition of risk exposure in areas such as
product liability, environmental damage and workers compensation. In
addition, individual state insurance departments may prevent premium rates
for some classes of insureds from reflecting the level of risk assumed by
the insurer for those classes. Such developments may adversely affect the
profitability of various lines of insurance. In some cases, these adverse
effects on profitability can be minimized through coverage re-pricing, if
permitted by applicable regulations, or limitations or cessation of the
affected business.
PAGE 26
ANALYSIS OF INSURANCE PROGRAM RESULTS OF OPERATIONS
The following tables summarize the net premiums earned and loss ratios
(computed by dividing losses and loss adjustment expenses by net premiums
earned) in each of the years presented. The "loss ratio" is based on losses
recorded during the calendar year presented regardless of the accident year
in which the claim occurred. The first table is summarized by major
insurance program and includes all lines of insurance written in each
program. The second table is summarized by line of insurance written and
includes all net premiums earned and net losses and loss adjustment expenses
incurred from all insurance programs for that particular line. See "Premiums
Earned" and "Losses and Loss Adjustment Expenses."
YEAR ENDED DECEMBER 31,
--------------------------------
2004 2005 2006
---------- ---------- ----------
(Dollars in thousands)
INSURANCE PROGRAMS
- ----------------------------------------
STANDARD LINES
Net premiums earned ................ $ 54,278 $ 54,979 $ 54,357
Loss ratio ......................... 79.0% 61.0% 74.0%
POLITICAL SUBDIVISIONS
Net premiums earned ................ $ 7,269 $ 6,690 $ 5,253
Loss ratio ......................... 98.0% 61.2% 51.3%
HOMEOWNERS
Net premiums earned ................ $ - $ 3,321 $ 5,353
Loss ratio ......................... -% 39.3% 47.0%
SURETY BONDS
Net premiums earned ................ $ 1,993 $ 669 $ 193
Loss ratio ......................... 134.4% (254.7)% (78.8)%
OTHER (1)
Net premiums earned ................ $ 502 $ 401 $ 548
Loss ratio ......................... 215.3% 29.7% 37.5%
TOTAL
Net premiums earned ................ $ 64,042 $ 66,060 $ 65,704
Loss ratio ......................... 84.0% 56.5% 69.2%
- -------------------------
<FN>
(1) This category is comprised primarily of the run-off of discontinued programs
and NAICO's participation in various mandatory workers compensation pools.
PAGE 27
YEAR ENDED DECEMBER 31,
--------------------------------
2004 2005 2006
---------- ---------- ----------
(Dollars in thousands)
LINES OF INSURANCE
- ----------------------------------------
AUTOMOBILE LIABILITY
Net premiums earned ................ $ 17,742 $ 19,126 $ 21,122
Loss ratio ......................... 61.2% 81.8% 99.5%
OTHER LIABILITY
Net premiums earned ................ $ 18,044 $ 18,052 $ 16,628
Loss ratio ......................... 120.9% 47.6% 56.9%
WORKERS COMPENSATION
Net premiums earned ................ $ 17,371 $ 16,475 $ 15,361
Loss ratio ......................... 85.5% 52.7% 63.3%
AUTOMOBILE PHYSICAL DAMAGE
Net premiums earned ................ $ 5,933 $ 5,807 $ 5,008
Loss ratio ......................... 42.9% 56.3% 62.6%
PROPERTY
Net premiums earned ................ $ 2,611 $ 5,594 $ 7,082
Loss ratio ......................... 46.8% 41.5% 41.3%
SURETY
Net premiums earned ................ $ 1,993 $ 669 $ 194
Loss ratio ......................... 134.4% (254.7)% (459.4)%
INLAND MARINE
Net premiums earned ................ $ 348 $ 337 $ 309
Loss ratio ......................... 29.5% 162.0% 30.0%
TOTAL
Net premiums earned ................ $ 64,042 $ 66,060 $ 65,704
Loss ratio ......................... 84.0% 56.5% 69.2%
PAGE 28
PREMIUMS EARNED
The following tables set 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 as well as each line of insurance for
each year presented:
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
---------------------------- ----------------------------
INSURANCE PROGRAMS 2004 2005 2006 2004 2005 2006
- -------------------------------- -------- -------- -------- -------- -------- --------
(In thousands)
Standard lines ................. $ 92,894 $ 92,224 $ 91,153 $ 54,278 $ 54,979 $ 54,357
Political subdivisions ......... 21,679 18,630 14,337 7,269 6,690 5,253
Homeowners ..................... - 4,229 8,542 - 3,321 5,353
Surety bonds ................... 2,788 930 278 1,993 669 193
Other .......................... 507 406 550 502 401 548
-------- -------- -------- -------- -------- --------
TOTAL .......................... $117,868 $116,419 $114,860 $ 64,042 $ 66,060 $ 65,704
======== ======== ======== ======== ======== ========
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
---------------------------- ----------------------------
LINES OF INSURANCE 2004 2005 2006 2004 2005 2006
- -------------------------------- -------- -------- -------- -------- -------- --------
(In thousands)
Other liability ................ $ 35,438 $ 33,944 $ 31,744 $ 18,044 $ 18,052 $ 16,628
Automobile liability ........... 26,660 28,031 31,615 17,742 19,126 21,122
Workers compensation ........... 26,995 25,769 23,562 17,371 16,475 15,361
Automobile physical damage ..... 9,154 8,914 7,720 5,933 5,807 5,008
Property ....................... 15,130 17,102 18,335 2,611 5,594 7,082
Surety ......................... 2,788 930 278 1,993 669 194
Inland marine .................. 1,703 1,729 1,606 348 337 309
-------- -------- -------- -------- -------- --------
TOTAL .......................... $117,868 $116,419 $114,860 $ 64,042 $ 66,060 $ 65,704
======== ======== ======== ======== ======== ========
Gross premiums earned decreased 1% in both 2005 and 2006. These
decreases were primarily the result of NAICO's continued efforts to
improve underwriting profitability, increased competition within the
Oklahoma school districts portion of the political subdivisions program,
and a decrease in surety bond premiums as NAICO no longer actively markets
this program. The decreases in gross premiums earned were partially offset
by premiums earned in the homeowners program which began during 2005. Gross
premiums earned in Texas decreased 4% and 12% in 2005 and 2006,
respectively, and gross premiums earned in Oklahoma decreased 4% and less
than 1% in 2005 and 2006.
Net premiums earned increased 3% and decreased 1% in 2005 and 2006,
respectively. Net premiums earned in the homeowners program offset the
decreases in net premiums earned in the political subdivisions and surety
bond programs in 2005 and 2006.
Gross premiums earned in the standard lines program decreased less than
1% in 2005 and 1% in 2006. Gross premiums earned in Texas decreased $4.9
million and $9.2 million in 2005 and 2006, respectively, and gross premiums
earned in Oklahoma increased $906,000 and $4.6 million in 2005 and 2006.
The decrease in Texas premiums was due primarily to a reduction in the
number of agents producing this business for NAICO, as NAICO has been
focusing on increasing premium production in Oklahoma and several other
states. NAICO has also increased premiums from trucking accounts in 2005 and
2006. Gross premiums earned from trucking accounts increased $6.4 million
and $8.9 million in 2005 and 2006, respectively, while net premiums earned
increased $3.3 million and $5.3 million in these periods. Net premiums
earned in the standard lines program increased 1% and decreased 1% in 2005
and 2006, respectively.
Gross premiums earned in the political subdivisions program decreased
14% and 23% in 2005 and 2006, respectively. The decrease in gross premiums
earned is due primarily to increased competition related to Oklahoma school
districts. Net premiums earned decreased 8% and 21% in 2005 and 2006,
respectively. 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.
In 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 homeowners program increased 102% and 61% in 2006. The
increase in net premiums earned was significantly less than the increase
in gross premiums earned due to an increase in the amount and cost of
reinsurance covering catastrophic exposures. NAICO discontinued this
program during the second quarter of 2006 due primarily to increased
catastrophic exposures.
PAGE 29
Gross premiums earned in the surety bond program decreased 67% and 70%
in 2005 and 2006, respectively. Net premiums earned decreased 66% and 71%
in 2005 and 2006, respectively. NAICO is no longer actively marketing its
surety bond program, and does not expect premium volume in this program to
increase in the future.
Other programs in the preceding table include premiums from the runoff
of various programs which are no longer offered by NAICO and NAICO's
participation in various mandatory pools covering workers compensation for
insureds that were unable to purchase this coverage from an insurance
company on a voluntary basis.
NET INVESTMENT INCOME AND NET REALIZED INVESTMENT GAINS
At December 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 24% 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 included $577,000
in interest from an arbitration award in 2004, and $6.6 million for the
accrual of prejudgment interest on a favorable jury verdict in civil
litigation regarding certain surety bond claims in 2006. See Litigation
and Note 10 of Notes to Consolidated Financial Statements.
Net investment income, excluding interest income from related parties
and interest from the arbitration award in 2004 and the prejudgment interest
accrual in 2006, increased 7% in 2005 and 13% in 2006. Interest income from
related parties was $491,000, $670,000 and $792,000 during 2004, 2005 and
2006, respectively. The increases were due primarily to higher interest
rates. See Liquidity and Capital Resources.
Net realized investment gains were $652,000, $383,000 and $745,000 in
2004, 2005 and 2006, respectively.
The average net yield on the fixed maturity portfolio, including net
realized investment gains, was 4.0%, 3.4% and 3.6% in 2004, 2005 and 2006,
respectively. The average net yield on the fixed maturity portfolio,
excluding net realized investment gains, was 3.2% for 2004, 3.4% for 2005
and 3.6% for 2006. Chandler USA excludes interest income from related
parties when calculating its average net yield on the portfolio. Chandler
USA's average net yield has been reduced by investment expenses to subsidize
a premium finance program for certain insureds of NAICO. While such
expenses reduce Chandler USA's average net yield, the premium finance
program enhances cash flow by providing cash which is available for
investment earlier than conventional deferred payment plans. Based on
information provided by the premium finance company, the outstanding
balance of premiums financed at December 31, 2006 was approximately $11.3
million. The average yield on the fixed maturity portfolio before
deducting investment expenses was 3.6% in 2004, 3.8% in 2005 and 4.0% in
2006, excluding net realized capital gains.
OTHER INCOME
During 2004, the remaining $368,000 of deferred gain related to a
sale and leaseback transaction for certain equipment was amortized into
income.
PAGE 30
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. See "BUSINESS - Reserves."
The percentage of losses and loss adjustment expenses to net premiums
earned ("loss ratio") was 84.0%, 56.5% and 69.2% in 2004, 2005 and 2006,
respectively. Weather-related losses (net of applicable reinsurance) from
wind and hail were $761,000, $475,000 and $727,000 in 2004, 2005 and 2006,
respectively, and increased the respective loss ratios by 1.2, 0.7 and 1.1
percentage points.
NAICO has experienced a significant amount of incurred losses related
to prior accident years during the 2004-2006 calendar years. The
adverse loss development is generally the result of ongoing analysis of
loss development trends for both liability and workers compensation lines
of business, and includes provisions for potentially uncollectible
reinsurance and deductibles. The development was primarily a function of
more adverse frequency and severity patterns than previously anticipated.
Since such development patterns were not present in the loss history
available at the time the earlier estimates were prepared, they could
therefore not be anticipated. NAICO adjusts reserves as experience
develops and new information becomes known. Such adjustments are
reflected in the results of operations in the periods in which the
estimates are changed. The adverse development of losses from prior
accident years results in higher calendar year loss ratios and reduced
calendar year operating results.
The following table sets forth the loss development by line of business
during each of the calendar years shown.
Calendar years
--------------------------------
2004 2005 2006
---------- ---------- ----------
(In thousands)
Other liability ..................... $ 15,537 $ 1,330 $ 590
Automobile liability ................ 1,082 4,562 3,028
Workers compensation ................ 7,580 1,387 994
Automobile physical damage .......... 194 255 261
Property ............................ 275 325 (47)
Surety .............................. 1,936 (1,844) (986)
Accident and health ................. (286) (26) 4
Inland marine ....................... 27 350 (15)
---------- ---------- ----------
$ 26,345 $ 6,339 $ 3,829
========== ========== ==========
In 2004, the majority of the adverse loss development was in the other
liability and workers compensation lines of business. Other liability claims
may not be reported for several years after the occurrence of a loss and may
not be settled for several years once reported. Workers compensation claims
may be paid out over several years. In 2005 and 2006, the majority of the
adverse loss development was in the automobile liability line of business, as
reserves were strengthened in the 1999-2005 accident years for this line of
business. A portion of this adverse development was offset by favorable
development in the surety line of business that resulted from an increase in
estimated recoveries primarily in the 1994 and 2001 accident years. The
1997-2001 accident years have clearly been the problematic years where the
loss development was so significant. During those years, NAICO's premium
volume grew from $123 million in 1997 to $197 million in 2000, before
dropping to $159 million in 2001. Much of that growth was attributable to
the planned expansion of NAICO's Texas business. This growth occurred at a
time when premium rates were very soft. The expansion into Texas began in
the last half of 1996. NAICO had written business in Texas for many years
with reasonably good experience. Based on this experience, management
believed the economic and tort climates were similar to Oklahoma. This did
not turn out as expected, especially in regards to business in south and
east Texas. Because this expansion was primarily a casualty driven book of
business, it took several years to realize that claims in many areas of
Texas were more severe and emerged differently than Oklahoma claims. As
the historical loss data picked up the development of these claims, the
projections of ultimate losses became more accurate.
PAGE 31
The following table sets forth the net reserves at the beginning of each
accident year, the loss development incurred during each calendar year, and
the re-estimated net reserves as of the beginning of each calendar year.
Accident years
------------------------------------------------------------------------------------------
Prior to
1998 1998 1999 2000 2001 2002 2003 2004 2005 Total
-------- -------- -------- -------- -------- -------- -------- -------- -------- ---------
(In thousands)
Reserves at beginning of 2004 .... $ 2,117 $ 146 $ 481 $ 1,879 $ 2,651 $ 6,554 $15,515 $ - $ - $ 29,343
Development during 2004 .......... 3,980 956 2,909 6,186 7,674 4,071 569 - - 26,345
-------- -------- -------- -------- -------- -------- -------- -------- -------- ---------
Re-estimated reserves at
beginning of 2004 ............... $ 6,097 $ 1,102 $ 3,390 $ 8,065 $ 10,325 $10,625 $16,084 $ - $ - $ 55,688
======== ======== ======== ======== ======== ======== ======== ======== ======== =========
Reserves at beginning of 2005 .... $ 4,194 $ 385 $ 610 $ 3,695 $ 3,242 $ 6,524 $ 8,833 $17,212 $ - $ 44,695
Development during 2005 .......... (354) 71 664 1,582 (50) 1,992 1,777 657 - 6,339
-------- -------- -------- -------- -------- -------- -------- -------- -------- ---------
Re-estimated reserves at
beginning of 2005 ............... $ 3,840 $ 456 $ 1,274 $ 5,277 $ 3,192 $ 8,516 $10,610 $17,869 $ - $ 51,034
======== ======== ======== ======== ======== ======== ======== ======== ======== =========
Reserves at beginning of 2006 .... $ 3,037 $ 218 $ (255) $ 1,579 $(2,444) $ 3,188 $ 5,896 $ 9,525 $19,805 $ 40,549
Development during 2006 .......... 881 182 726 68 (1,678) 663 (996) 108 3,875 3,829
-------- -------- -------- -------- -------- -------- -------- -------- -------- ---------
Re-estimated reserves at
beginning of 2006 ............... $ 3,918 $ 400 $ 471 $ 1,647 $(4,122) $ 3,851 $ 4,900 $ 9,633 $23,680 $ 44,378
======== ======== ======== ======== ======== ======== ======== ======== ======== =========
During 2004, NAICO experienced adverse loss development totaling $26.3
million primarily in the standard lines and political subdivisions programs.
This adverse development was due primarily to continued increases in losses
in the workers compensation and other liability lines of business in the
1997-2002 accident years. Adverse loss development for other liability was
$15.5 million. Adverse loss development for workers compensation, surety
bonds and automobile liability were $7.6 million, $1.9 million and $1.1
million, respectively. Involuntary workers compensation pools experienced
$803,000 in adverse loss development, with $703,000 of this in 1996 and
prior accident years. NAICO records losses based on information obtained
from the pools plus an accrual for the lag time in reporting. The adverse
loss development included approximately $409,000 for provisions for
potentially uncollectible reinsurance and deductibles. Reserves for
unpaid losses and loss adjustment expenses, net of related reinsurance
recoverables, were $44.7 million at December 31, 2004 compared to $29.3
million at December 31, 2003, an increase of $15.4 million or 52%.
During 2005, NAICO experienced adverse loss development totaling $6.3
million primarily in the standard lines and political subdivisions programs.
A portion of the adverse development was offset by favorable development of
$1.8 million in the surety bond program, primarily in accident years 1994
and 2001 that resulted from the estimated recoveries discussed previously.
The adverse development was due primarily to an increase in losses in the
workers compensation, other liability and automobile liability lines of
business in the 2000, 2002 and 2003 accident years. The adverse loss
development included approximately $108,000 for provisions for potentially
uncollectible reinsurance.
During 2006, NAICO experienced adverse loss development totaling $3.8
million primarily in the standard lines program. A portion of the adverse
development was offset by favorable development of $1.0 million in the
surety bond program, primarily in the 2001 accident year, that resulted
from the estimated recoveries discussed previously. The adverse
development was due primarily to an increase in losses in the automobile
liability line of business in the 2005 accident year and in the workers
compensation line of business in the 1997 and 1999 accident years. The
adverse loss development included approximately $97,000 for provisions
for potentially uncollectible reinsurance.
In the last five years, management has undertaken several initiatives
to improve the quality and profitability of business. These initiatives
included significant rate increases, changes in coverage forms that limit
or eliminate coverage, reduction or elimination of classes of business
that have not been profitable, reduction or elimination of business in
geographic areas that have not been profitable and increased emphasis on
risk selection. Management has also improved case reserving which
improves the overall reserving accuracy and also leads to better
underwriting decisions.
Reinsurance contracts do not relieve an insurer from its obligation
to policyholders. Failure of reinsurers to honor their obligations could
result in losses to Chandler USA; consequently, adjustments to ceded
losses and loss adjustment expenses are made for amounts deemed
uncollectible. During 2004, 2005 and 2006, NAICO incurred charges of
$282,000, $108,000 and $97,000, respectively, in adjustments to ceded
losses and loss adjustment expenses for amounts deemed uncollectible.
NAICO did not receive any claims related to the September 11, 2001
terrorist attacks on the World Trade Center and does not believe that it
has any significant exposure to these and related losses. While several
of NAICO's reinsurers did experience significant losses related to these
attacks, it currently does not appear that these losses will impair the
reinsurers' ability to pay claims.
PAGE 32
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 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 years ended December 31, 2004, 2005 and 2006:
<TABLE
YEAR ENDED DECEMBER 31,
--------------------------------
2004 2005 2006
---------- ---------- ----------
(In thousands)
Commissions expense ............................. $ 16,078 $ 17,186 $ 15,933
Other premium related assessments ............... 1,137 960 1,061
Premium taxes ................................... 2,562 2,205 2,020
Excise taxes .................................... 301 272 272
Other expense ................................... 458 723 730
---------- ---------- ----------
Total direct expenses ........................... 20,536 21,346 20,016
Indirect underwriting expenses .................. 7,463 6,384 6,296
Commissions received from reinsurers ............ (17,068) (15,891) (15,026)
Adjustment for deferred acquisition costs ....... 108 (1,168) 380
---------- ---------- ----------
Net policy acquisition costs .................... $ 11,039 $ 10,671 $ 11,666
========== ========== ==========
Total gross direct and indirect expenses as a percentage of direct
written and assumed premiums were 23.0% in both 2004 and 2005, and 23.3% in
2006. For these periods, commission expense as a percentage of gross
written and assumed premiums was 13.2%, 14.3% and 14.1%. The increase in
2005 in commission expense was due primarily to the homeowners program that
began during 2005. This 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 6.1%, 5.3% and 5.6% of total direct
written and assumed premiums in 2004, 2005 and 2006, respectively. The
decreases in 2005 and 2006 were due primarily to a reduction in employee
related expenses. 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 percentage of ceded reinsurance premiums were 33.3%, 31.6%
and 31.1% in 2004, 2005 and 2006, respectively.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were 10.5%, 11.0% and 10.9% of
gross premiums earned in 2004, 2005 and 2006, respectively. General and
administrative expenses in 2004 included a recovery of certain litigation
expenses of $359,000. 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 revenues.
INTEREST EXPENSE
Interest expense increased 6% in both 2005 and 2006. Substantially
all of Chandler USA's interest expense is related to its outstanding senior
debentures and junior subordinated debentures. The increases in 2005 and
2006 were due primarily to the increase in interest rates during these
periods, as a portion of Chandler USA's junior subordinated debentures were
issued with a floating interest rate.
PAGE 33
FEDERAL INCOME TAXES
Chandler USA's federal income tax benefit (provision) as a percentage
of income (loss) before income taxes was 33.8%, 35.6% and 32.9% for 2004,
2005 and 2006, respectively.
At December 31, 2006, Chandler USA had a net deferred tax asset of $4.0
million including $1.6 million related to federal net operating loss
carryforwards which begin to expire in 2024. Chandler USA believes it is
more likely than not that the deferred income tax asset including the
federal net operating loss carryforwards will be realized through future
earnings. As a result, a valuation allowance has not been recorded.
Chandler USA used the same assumptions as in internal financial projections
to estimate future taxable income. If Chandler USA's results are not as
profitable as anticipated, a valuation allowance may have to be established
for the federal net operating loss carryforwards and the other remaining
deferred tax assets.
LIQUIDITY AND CAPITAL RESOURCES
Chandler USA is a holding company receiving cash principally through
borrowings, subsidiary dividends and other payments, subject to various
regulatory restrictions described in "Regulation" and the Notes to
Consolidated Financial Statements. 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, 2006, NAICO had statutory earned surplus of $14.0
million. Applying the Oklahoma statutory limits described above, the
maximum shareholder dividend NAICO may pay in 2007 without the approval
of the Oklahoma Department of Insurance is $5.2 million. NAICO paid
shareholder dividends to Chandler USA totaling $3.4 million in June of
2004.
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 below. 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.
PAGE 34
NAICO maintains a liquid operating position and follows investment
guidelines that are intended to provide for an acceptable return on
investment while preserving capital, maintaining sufficient liquidity to
meet obligations and keeping a sufficient margin of capital and surplus
to ensure unimpaired ability to write insurance. As of December 31, 2006,
all of NAICO's fixed-maturity investments were rated Aa3 or A+ or better by
Moody's Investors Service, Inc. or Standard & Poor's, respectively.
NAICO purchases investments to support its investment strategies which
are developed based on many factors including rate of return, maturity,
credit risk, tax considerations, regulatory requirements and its mix of
business. As of December 31, 2006 all of the investments of NAICO were in
fixed-maturity investments, equity securities, mutual funds that invest in
equity securities, interest-bearing money market accounts and collateralized
repurchase agreements. At the time of purchase, investments in debt
securities that NAICO has the positive intent and ability to hold to
maturity are classified as held to maturity and reported at amortized cost;
all other debt securities are reported at fair value. Investments
classified as trading are actively and frequently bought and sold with
the objective of generating income on short-term differences in price.
Realized and unrealized gains and losses on securities classified as
trading account assets are recognized in current operations. NAICO has not
classified any investments as trading account assets. Debt securities not
classified as held to maturity or trading and equity securities are
classified as available for sale, with the related unrealized gains and
losses excluded from earnings and reported net of deferred income tax as a
separate component of other comprehensive income until realized.
Chandler USA provided $20.2 million in cash from operations in 2004,
used $131,000 in cash from operations in 2005 and provided $4.4 million in
cash from operations in 2006. The cash provided by operations in 2004 was
due primarily to the decrease in reinsurance purchased in 2004 which
resulted in an increase in net premiums written of $18.6 million. Cash
flow from operations is positively impacted during times when net premiums
written increase since a substantial portion of the claim payments for any
given year will be made in future years. The cash provided by operations
was used primarily to fund purchases of investments and loans to related
parties. During 2005, net premiums written decreased slightly which
attributed to Chandler USA using only $131,000 in cash from operations. In
2005, the increase in premium receivables and reinsurance recoverables on
unpaid losses were offset by Chandler USA's net income and an increase in
unearned premium. The cash provided by operations in 2006 included a
decrease in reinsurance recoverable on unpaid losses of $29.2 million, but
this was largely offset by a decrease in unpaid losses and loss adjustment
expenses of $26.3 million. These decreases were primarily the result of
recording additional estimated recoveries related to a favorable jury
verdict in civil litigation regarding certain surety bond claims during
2006. See "Litigation."
Cash flows from investing activities were primarily the result of
normal purchases and sales of investment securities. Net realized
investment gains before income taxes were $652,000, $383,000 and $745,000
during 2004, 2005 and 2006, respectively, from the sale of investments.
NAICO received proceeds of $23.8 million, $2.5 million and $21.3 million
during 2004, 2005 and 2006, respectively, from the sale of available for
sale securities prior to their maturity. During 2004, 2005 and 2006, the
market value of NAICO's available for sale fixed-income investments
decreased by $581,000, $1.6 million and $1,000, respectively, due
primarily to changes in interest rates experienced during this time. The
average maturity of NAICO's fixed maturity investments was 4.0 years and
3.4 years at December 31, 2005 and 2006, respectively.
Cash flows from financing activities were primarily the result of
payments and loans between Chandler USA and Chandler Insurance. Chandler
USA and Chandler Insurance are parties to 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. At December 31,
2005 and 2006, Chandler USA had a receivable of $9.4 million and $9.6
million, respectively, under the Credit Agreement, and Chandler USA
earned $439,000, $614,000 and $733,000 in interest income under the
Credit Agreement during 2004, 2005 and 2006, respectively.
NAICO is required to deposit securities with regulatory agencies in
several states in which it is licensed as a condition of conducting
operations in the state. At December 31, 2006, the total amount of cash
and investments restricted as a result of these arrangements was $7.7
million. In addition, NAICO has deposited $11.9 million of cash and
investments into a trust account as collateral for a reinsurance
agreement in which NAICO is the assuming reinsurer.
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 three years with
monthly rental installments equal to the sum of (i) $17,512 plus
(ii) interest, which was 9.25% at December 31, 2006, on the unpaid
lease balance which is a floating interest rate of 1% over JP Morgan
Chase Bank prime. During March 2007, the lease was extended for an
additional three years with monthly rental installments equal to the
sum of (i) $13,834 plus (ii) interest on the unpaid lease balance at
1% over JP Morgan Chase Bank prime. Chandler USA has the option to
repurchase the equipment at the end of the lease for approximately
$1.9 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 $1.5 million. See Note
11 to Consolidated Financial Statements.
PAGE 35
CONTRACTUAL OBLIGATIONS
The following table provides the future payments due by period under
contractual obligations as of December 31, 2006, aggregated by type of
obligation:
LESS THAN 1-3 3-5 MORE THAN
ONE YEAR YEARS YEARS 5 YEARS TOTAL
---------- --------- --------- --------- ----------
(In thousands)
Unpaid losses and loss adjustment
expenses (1) ....................... $ 35,269 $ 32,232 $ 12,489 $ 3,263 $ 83,253
Future minimum rental payments
under operating leases ............. 232 102 - - 334
Guaranteed residual value of
operating lease (2) ................ 1,518 - - - 1,518
Capital leases ....................... 48 84 17 - 149
Debentures ........................... - - - 6,979 6,979
Junior subordinated debentures
issued to affiliated trusts ........ - - - 20,620 20,620
---------- --------- --------- --------- ----------
Total .............................. $ 37,067 $ 32,418 $ 12,506 $ 30,862 $ 112,853
========== ========= ========= ========= ==========
- ------------------------------------------
<FN>
(1) The amounts presented are estimates of the dollar amounts and time period in which NAICO
expects to pay out its gross unpaid losses and loss adjustment expenses. These amounts are
based on historical payment patterns and do not represent actual contractual obligations. The
actual payment amount and the related timing of those amounts could differ significantly from
these estimates.
(2) This amount represents the specified maximum deficiency that Chandler USA could be required
to make up under the sale and leaseback transaction described previously.
LITIGATION
On August 1, 2006, a jury trial concluded in Harris County, Texas,
related to the construction of two gas processing plants in Louisiana.
NAICO had provided surety bonds in connection with the construction of
these plants. The amounts the jury found owing to NAICO include
approximately $20.2 million in actual damages and $70.0 million in
punitive damages. See Note 10 of Notes to Consolidated Financial
Statements for a discussion of this jury verdict.
On October 30, 2006, NAICO filed its Motion for Entry of Judgment
requesting that the Trial Court enter judgment for a total of $100.6 million
plus court costs and anticipated attorney fees for appeals. This amount
includes $70.0 million in punitive damages, $8.3 million in prejudgment
interest through November 1, 2006, and attorney fees of $4.6 million through
entry of judgment. The Trial Court denied the request for attorney fees on
January 5, 2007. NAICO expects the Trial Court to enter judgment based upon
its request during 2007. When entering judgment, the Court may enter
judgment based upon NAICO's request or may enter a different judgment.
After judgment is entered, all parties may file post-judgment motions.
Following the Court's rulings on post-judgment motions, all parties may
appeal all or any of those rulings or judgments.
During the third quarter of 2006, NAICO increased the estimated
recovery on the surety bond claims related to the construction of the two
gas processing plants which resulted in a decrease in losses and loss
adjustment expenses incurred of $4.7 million. In addition, unpaid losses
and loss adjustment expenses decreased $22.7 million, reinsurance
recoverable on unpaid losses and loss adjustment expenses decreased
$16.8 million, and reinsurance recoverable on paid losses and loss
adjustment expenses decreased $1.2 million. NAICO also recorded $6.6
million of interest income for its estimate of prejudgment interest
through December 31, 2006, including a recovery for a pre-verdict settlement
with certain other parties. Prejudgment interest will continue to accrue at
8.25%.
NEW ACCOUNTING STANDARDS
See Note 1 to Consolidated Financial Statements for a discussion of
recently issued accounting pronouncements.
PAGE 36
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Chandler USA's consolidated balance sheets include a certain amount of
assets and liabilities whose fair values are subject to market risk. Due to
Chandler USA's significant investment in fixed-maturity investments, interest
rate risk represents the largest market risk factor affecting Chandler USA's
consolidated financial position. Increases and decreases in prevailing
interest rates generally translate into decreases and increases in fair
values of those instruments. Additionally, fair values of interest rate
sensitive instruments may be affected by the credit worthiness of the
issuer, prepayment options, relative values of alternative investments,
liquidity of the instrument and other general market conditions.
As of December 31, 2006, substantially all of the investments of NAICO
were in fixed-maturity investments (rated Aa3 or A+ or better by Moody's
Investors Service, Inc. or Standard & Poor's, respectively), equity
securities, mutual funds that invest in equity securities, interest-bearing
money market accounts and collateralized repurchase agreements. NAICO does
not hold any investments classified as trading account assets or derivative
financial instruments.
The table below summarizes the estimated effects of hypothetical
increases and decreases in interest rates on NAICO's fixed-maturity
investment portfolio. It is assumed that the changes occur immediately and
uniformly, with no effect given to any steps that management might take to
counteract that change. The hypothetical changes in market interest rates
reflect what could be deemed best and worst case scenarios. The fair
values shown in the following table are based on contractual maturities.
Significant variations in market interest rates could produce changes in
the timing of repayments due to prepayment options available. The fair
value of such instruments could be affected and, therefore, actual results
might differ from those reflected in the following table:
Estimated
fair value after
Hypothetical hypothetical
Fair value at change in change in
December 31, interest rate interest rate
---------------------- (bp=basis points) ----------------------
2005 2006 2005 2006
---------- ---------- ----------------- ---------- ----------
(Dollars in thousands) (Dollars in thousands)
Fixed-maturity investments ... $ 71,735 $ 66,379 100 bp increase.. $ 69,120 $ 64,392
200 bp increase.. 66,657 62,520
100 bp decrease.. 74,516 68,431
200 bp decrease.. 77,477 70,613
The table above illustrates, for example, that an instantaneous 200
basis point increase in market interest rates at December 31, 2006 would
reduce the estimated fair value of NAICO's fixed-maturity investments by
approximately $3.9 million at that date.
NAICO's portfolio of equities and equity mutual funds has exposure
to equity price risk. Equity price risk is defined as the potential loss
in fair value resulting from an adverse change in prices. The mutual funds
primarily invest in equity securities of large U.S. entities across a variety
of industries. These funds are managed by the individual fund managers, and
NAICO's Investment Committee monitors the performance of these mutual funds.
The equities and equity mutual funds are carried on the balance sheet at fair
value. The changes in estimated fair value of the equity portfolio are
presented as a component of shareholder's equity in accumulated other
comprehensive income, net of taxes.
The table below summarizes NAICO's equity price risk and shows the
effect of a hypothetical 20% increase and a 20% decrease in market prices
as of December 31, 2005 and 2006. The selected hypothetical changes do not
indicate what could be the potential best or worst case scenarios.
Estimated
fair value after
Fair value at hypothetical
December 31, Hypothetical change in prices
---------------------- price change ----------------------
2005 2006 2005 2006
---------- ---------- ----------------- ---------- ----------
(Dollars in thousands) (Dollars in thousands)
Equity securities ............ $ 9,071 $ 1,921 20% increase .... $ 10,885 $ 2,305
20% decrease .... 7,257 1,537
PAGE 37
Chandler USA is obligated for $7.0 million principal amount of
Debentures that have a maturity date of July 16, 2014. The Debentures have
a fixed interest rate of 8.75%. At December 31, 2006, the fair value of
Chandler USA's Debentures was estimated to be $5.8 million based on the
latest reported trade. Chandler USA's Debentures have not historically
traded regularly, and settlement at the reported fair value may not be
possible. The Debentures are redeemable by Chandler USA on or after July
16, 2009 without penalty or premium, but may be purchased and cancelled by
Chandler USA at a price of less than the sum of the principal amount and
accrued interest at any time. Chandler USA is obligated for $13.4 million
principal amount of junior subordinated debentures that mature in 2033 with
a fixed interest rate of 9.75%, and $7.2 million principal amount of junior
subordinated debentures that mature in 2034 with a floating rate of 4.10%
over LIBOR. The interest rate was 9.47% at December 31, 2006. At December
31, 2006, the fair value of Chandler USA's junior subordinated debentures was
estimated to be $21.7 million.
During March 2001, Chandler USA entered into a $3.8 million sale and
leaseback transaction for certain owned equipment for three years. The sale
and leaseback transaction resulted in a deferred gain of $2.0 million which
was amortized into income over the final year of the lease, resulting in
other income of $1.7 million in 2003 and $368,000 in 2004. During March
2004, the lease was extended for three years with monthly rental
installments equal to the sum of (i) $17,512 plus (ii) interest, which was
9.25% at December 31, 2006, on the unpaid lease balance which is a floating
interest rate of 1% over JP Morgan Chase Bank prime. During March 2007,
the lease was extended for an additional three years with monthly rental
installments equal to the sum of (i) $13,834 plus (ii) interest on the
unpaid lease balance at 1% over JP Morgan Chase Bank prime. Chandler USA
has the option to repurchase the equipment at the end of the lease for
approximately $1.9 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 $1.5 million.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See Item 15(a)1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
ITEM 9A. 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
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, Chandler USA's internal control over financial
reporting.
ITEM 9B. OTHER INFORMATION.
None.
PAGE 38
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
DIRECTORS AND EXECUTIVE OFFICERS
A brief description of each director and executive officer of Chandler
USA is provided below. Directors hold office until the next annual meeting
of shareholders or until their respective successors are duly elected and
qualified. Executive officers are elected by the Board of Directors at its
annual meeting and hold office until its next annual meeting or until their
respective successors are duly elected and qualified. The current directors
and executive officers of Chandler USA are as follows:
NAME AGE POSITION
- -------------------- --- ---------
W. Brent LaGere 61 Chairman of the Board, Chief Executive Officer, Compensation
Committee Member and Director.
Mark T. Paden 50 President, Compensation Committee Member and Director.
Lance A. LaGere 26 Executive Vice President and Chief Operating Officer
Richard L. Evans 60 Senior Vice President and Director.
R. Patrick Gilmore 55 Senior Vice President, Secretary, General Counsel and Director.
Mark C. Hart 51 Senior Vice President-Finance, Chief Financial Officer and Treasurer.
M. Steven Blain 49 Vice President-Administration.
Robert L. Rice 72 Audit Committee Chairman and Director.
W. Scott Martin 56 Audit Committee Member and Director.
William T. Keele 70 Audit Committee Member and Director.
W. BRENT LAGERE has been a director, Chairman of the Board and Chief
Executive Officer of Chandler USA since 1988 and of CIMI since December 2002.
Since 1988, Mr. LaGere has served in officer and director capacities for
various subsidiaries of Chandler USA pursuant to an employment contract
with Chandler USA. Mr. LaGere serves as Chairman of the Board and Chief
Executive Officer of Chandler Insurance.
MARK T. PADEN has served as President of Chandler USA and NAICO since
May 2001 and as Chief Operating Officer of Chandler USA and NAICO from May
1998 to February 2006. Mr. Paden has served as President of CIMI since
December 2002 and Chief Operating Officer of CIMI from December 2002 to
February 2006. From May 1998 to May 2001, Mr. Paden also served as
Executive Vice President of Chandler USA and NAICO. Mr. Paden has served
as Chief Financial Officer of NAICO from January 1988 through May 2001
and also served as Vice President-Finance of NAICO from January 1988
through May 1998. Mr. Paden has been a director of Chandler USA since
July 1988, NAICO since November 1992 and CIMI since December 2002. Mr.
Paden also serves as a director and President of Chandler Insurance.
LANCE A. LAGERE has served as Executive Vice President of NAICO since
January 2006, and of Chandler USA and CIMI since February 2006. Mr. LaGere
has also served as Chief Operating Officer of these companies since February
2006. From December 2002 to December 2005, Mr. LaGere was a retail insurance
agent for Brown & Brown of Central Oklahoma, Inc. From June 2002 to December
2002, Mr. LaGere was a retail insurance agent for LaGere & Walkingstick
Insurance Agency, Inc., which was a wholly owned subsidiary of Chandler USA
until its sale to Brown & Brown, Inc. in December 2002. Mr. LaGere was also
appointed as Executive Vice President of Chandler Insurance during 2006,
pending approval by the Cayman Islands Monetary Authority. Mr. LaGere is the
son of W. Brent LaGere, Chairman of the Board and Chief Executive Officer of
Chandler USA.
RICHARD L. EVANS has been a director of Chandler USA since May 1990. He
has been Senior Vice President of Chandler USA and NAICO since March 1999,
and served as Vice President of NAICO since 1987, and of Chandler USA since
1989. Mr. Evans also serves as Senior Vice President of Chandler Insurance.
PAGE 39
R. PATRICK GILMORE has served as General Counsel for Chandler USA and
its subsidiaries since 1988 and currently serves as corporate Secretary and
Senior Vice President. Mr. Gilmore has been a director of Chandler USA since
May 1990 and NAICO since September 2000.
MARK C. HART has served as Senior Vice President-Finance and Treasurer of
Chandler USA and NAICO since May 1998, and has served as Chief Financial
Officer of Chandler USA and NAICO since May 2001. Mr. Hart has also served
as Vice President of Chandler USA since March 1994. Mr. Hart has served as
Treasurer of CIMI since December 2002. Mr. Hart also serves as Vice
President-Accounting, Chief Financial Officer and Treasurer of Chandler
Insurance.
M. STEVEN BLAIN has served as Vice President-Administration of Chandler
USA and NAICO since August 2003. From November 1999 to August 2003, Mr.
Blain was employed by NAICO in various capacities. Prior to his employment
by NAICO in November 1999, Mr. Blain was Vice President-Operations and
Chief Financial Officer for J.B. Pratt Foods, Inc.
ROBERT L. RICE has been a director of Chandler USA since June 1993 and
a director of NAICO since March 2000. He has for more than 20 years engaged
in private practice as a Certified Public Accountant.
W. SCOTT MARTIN has been a director of Chandler USA and NAICO since
March 2000. Mr. Martin has been President of the Tulsa Loan Production
Office with First Bank & Trust Company in Wagoner, Oklahoma since 1994.
Mr. Martin also serves as a director of First Bank & Trust in Wagoner,
Oklahoma, First Bank of Chandler in Chandler, Oklahoma, First National
Bank in Burkburnett, Texas and First Bank in Ketchum, Oklahoma. Mr. Martin
is also the Manager for Basin Management, LLC.
WILLIAM T. KEELE has been a director of Chandler USA and NAICO since
May 2001. Mr. Keele has been President of Hallman & Keele, Inc., a
construction and steel fabrication firm, since 1974.
AUDIT COMMITTEE FINANCIAL EXPERT
Chandler USA's Audit Committee is composed of Messrs. Rice, Martin and
Keele, with Mr. Rice serving as Chairman. Chandler USA's Board of Directors
has determined that Mr. Rice is an "audit committee financial expert", as
defined by Securities and Exchange Commission rules. Mr. Rice is an
independent director, as that term is used in Item 7(d)(3)(IV) of Schedule
14A under the Securities Exchange Act of 1934.
CODE OF ETHICS
Chandler USA has adopted a Code of Ethics for Principal Executive and
Senior Financial Officers, a copy of which was filed as Exhibit 14.1 to
Chandler USA's Form 10-K for the fiscal year ended December 31, 2003.
COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934
Based solely upon a review of Forms 3, 4 and 5, any amendments thereto
furnished to Chandler USA pursuant to the rules of the Securities and
Exchange Commission, or written representations from certain reporting
persons presented to Chandler USA, all such reports required to be filed
by reporting persons have been filed in a timely fashion during the fiscal
year ended December 31, 2006.
PAGE 40
ITEM 11. EXECUTIVE COMPENSATION.
COMPENSATION DISCUSSION AND ANALYSIS
This section provides information regarding the compensation of our
Chief Executive Officer, Chief Financial Officer and, in addition, our
three most highly compensated executive officers. Collectively, we refer
to these executives as the named executive officers. Our executive
compensation program is developed and monitored by our Compensation
Committee which consists of our Chief Executive Officer and our President.
COMPENSATION PROGRAM OBJECTIVES
Our overall goal in compensating executive officers is to attract,
retain and motivate key executives who are critical to our future success.
We want to reinforce our goal to grow our business profitably and to reward
each executive's contributions toward this goal. Our decisions with respect
to executive officer salaries and incentives are influenced by the
executive's level of responsibility and function within Chandler USA as
well as the overall performance and profitability of Chandler USA.
EXECUTIVE COMPENSATION ELEMENTS
Our Compensation Committee reviews the performance results of each
named executive officer and establishes individual compensation levels.
Our executive compensation program consists of base salaries, cash bonuses
and perquisites.
BASE SALARIES
The purpose of the base salary is to reflect each executive's job
responsibilities and to reward each executive's job performance. During
2006, the following base salaries were approved for our named executive
officers:
PERCENTAGE
NAMED EXECUTIVE OFFICER 2006 BASE SALARY INCREASE
- -------------------------------- ---------------- ----------
W. Brent LaGere ................ $ 546,740 2.1%
Mark T. Paden .................. 333,714 3.0%
Richard L. Evans ............... 277,068 3.0%
R. Patrick Gilmore ............. 248,558 3.0%
Mark C. Hart ................... 172,105 3.0%
Base annual salaries are evaluated at least annually on the officer's
anniversary date for each of the named executive officers. This evaluation
includes recommendations from the Chief Operating Officer for certain of the
executive officers. At that time, the Compensation Committee determines the
base salary adjustment for each executive officer. The factors that
influence the determination include the executive's experience, performance,
changes in responsibilities and budgetary considerations.
Chandler USA has an employment agreement with W. Brent LaGere, Chairman
of the Board and Chief Executive Officer of Chandler USA and its subsidiaries.
Under this agreement, Mr. LaGere's base compensation is established at not
less than $250,000 per year. In the event that Mr. LaGere is terminated
without cause, as defined in the agreement, he is entitled to receive his base
compensation for the remainder of the term of the agreement, but in no event
for more than 60 months. The agreement will terminate upon Mr. LaGere
attaining age 70, unless earlier terminated by Chandler USA for cause.
CASH BONUSES
While the company does not have a formal incentive bonus program, all of
the named executive officers are eligible to receive cash bonuses. The amount
of cash bonuses to be paid are determined at the discretion of the Compensation
Committee. During 2006, the Compensation Committee awarded cash bonuses to Mr.
LaGere and Mr. Paden as shown in the Summary Compensation Table that follows.
These cash bonuses were paid during 2006.
PAGE 41
PERQUISITES
Each of the named executive officers participate in employee benefit plans
generally available to our employees, including medical, life insurance,
disability plans and our defined contribution 401(k) retirement plan. Other
perquisites such as company provided automobiles, additional disability and
life insurance are also provided to certain named executive officers. In
addition, various personal expenses are paid for on behalf of our Chief
Executive Officer and President, and these expenses and related income tax
gross-ups are reported as "All Other Compensation" in the Summary Compensation
Table that follows. The amount and nature of the personal expenses to be paid
are determined at the discretion of the Compensation Committee.
ROLE OF EXECUTIVE OFFICERS IN DETERMINING COMPENSATION
Our Compensation Committee consists of our Chief Executive Officer and
President. These two individuals also own 100% of the outstanding common
stock of our ultimate parent company. As such, they determine the levels of
their own compensation including cash bonuses and perquisites. They also
determine the levels of compensation, with input from the Chief Operating
Officer, for each of the other named executive officers.
The following table sets forth the compensation paid or to be paid by
Chandler USA or any of its subsidiaries as well as all other compensation
paid or accrued to the Chief Executive Officer, Chief Financial Officer, and
the three other most highly compensated executive officers of Chandler USA
and its subsidiaries during the years indicated.
SUMMARY COMPENSATION TABLE
ALL OTHER
NAME AND PRINCIPLE POSITION YEAR SALARY BONUS COMPENSATION(1) TOTAL
- -------------------------------- ---- ---------- ---------- --------------- ------------
W. Brent LaGere, Chairman
of the Board and CEO 2006 $ 537,544 $ 574,269 $ 819,886 $ 1,931,699
Mark T. Paden, President 2006 332,904 563,432 98,204 994,540
Richard L. Evans, Senior
Vice President - Claims 2006 276,396 - 21,383 297,779
R. Patrick Gilmore, Senior
Vice President, Secretary
and General Counsel 2006 243,731 - 13,102 256,833
Mark C. Hart, Senior
Vice President - Finance,
Chief Financial Officer
and Treasurer 2006 170,225 - 6,100 176,325
- -----------------------------------------
<FN>
(1) The amounts shown in this column include matching contributions under Chandler USA's
401(k) plan, life and disability insurance premiums and various perquisites and tax gross-ups
as detailed below.
SUPPLEMENTAL TABLE FOR ALL OTHER COMPENSATION
401(K) LIFE OTHER
COMPANY INSURANCE PERSONAL TAX
NAMED EXECUTIVE OFFICER YEAR MATCH (1) PREMIUMS (2) EXPENSES (3) GROSS-UPS (4) TOTAL
- ------------------------- ---- --------- ------------ ------------ ------------- ----------
W. Brent LaGere ......... 2006 $ 6,100 $ 75,953 $ 429,622 $ 308,211 $ 819,886
Mark T. Paden ........... 2006 6,100 3,900 54,615 33,589 98,204
Richard L. Evans ........ 2006 6,100 5,000 6,557 3,726 21,383
R. Patrick Gilmore ...... 2006 6,100 2,000 3,474 1,528 13,102
Mark C. Hart ............ 2006 6,100 - - - 6,100
- ----------------------------
<FN>
(1) The amounts shown in this column reflect company matching contributions under our 401(k) plan.
PAGE 42
(2) The amounts shown in this column reflect the premiums paid or to be paid
under life insurance arrangements with the named executive officers. A
portion of the premiums ($30,153 for Mr. LaGere, $2,500 for Mr. Paden,
$5,000 for Mr. Evans and $2,000 for Mr. Gilmore) were paid under a split
dollar life insurance plan. Under this plan, Chandler USA or its
subsidiaries pay the premiums for life insurance issued to the named
executive officer. Repayment of the premiums is secured by the death
benefit or the cash surrender value of the policy, if any, if the named
executive officer cancels and surrenders the policy.
(3) The amounts shown in this column reflect various personal expenses, none
of which individually exceeded the greater of $25,000 or ten percent of
total perquisites for each named executive officer except as disclosed
below. Personal expenses included company provided automobiles, payment
of disability insurance premiums and sporting event tickets for Messrs.
LaGere, Paden, Evans and Gilmore. In addition, the amounts shown for
Mr. LaGere and Mr. Paden include automobile lease payments for each of
their spouses, gasoline and other automobile related expenses for their
spouses and other family members, club memberships and related expenses,
payments for personal automobile insurance premiums and personal flights
on company provided aircraft. The incremental cost to the company of
the personal use of company provided aircraft is calculated based on the
variable operating cost per flight hour. Mr. LaGere's personal expenses
also included home and housing related expenses, personal tax return and
legal services, computer purchases, expenses related to personal
investments and payments for personal charges on personal credit cards
of $216,116 during 2006.
(4) The amounts shown in this column represent the income tax gross-ups for
each of the named executive officers that relate to certain personal
expenses and life insurance premiums.
COMPENSATION OF DIRECTORS
Directors who are employees of Chandler USA do not receive additional
compensation for serving as directors. Each non-employee director of
Chandler USA is paid $1,000 per day for any meeting or committee meeting
attended. However, if a non-employee director is attending meetings for
two or more affiliates of Chandler USA on the same day, his compensation
is $750 per day for any meeting or committee meeting of Chandler USA
attended. Each non-employee director is also paid $1,500 per day for any
NAICO board meeting attended. If a non-employee director attends the
meeting by telephonic conference, his compensation is $500 per day for any
meeting or committee meetings so attended. As Chairman of the Audit
Committee, Mr. Rice's compensation for audit committee meetings is 150%
of the applicable meeting fee.
The following table sets forth the compensation earned by our
non-employee directors for 2006.
DIRECTOR COMPENSATION
FEES EARNED
NAME OR PAID IN CASH TOTAL
- ------------------------------ ------------------ -------------
Robert L. Rice ............... $ 12,375 $ 12,375
W. Scott Martin .............. 10,750 10,750
William T. Keele ............. 10,750 10,750
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Chandler USA's Compensation Committee consists of W. Brent LaGere and
Mark T. Paden. Mr. LaGere is the Chief Executive Officer of Chandler USA
and its subsidiaries, and is also a director of Chandler USA's sole
shareholder Chandler Insurance. Mr. Paden is President of Chandler USA
and its subsidiaries, and is also a director of Chandler Insurance.
Chandler Insurance has no employees and does not have a compensation
committee.
COMPENSATION COMMITTEE REPORT
The Compensation Committee has reviewed and discussed the Compensation
Discussion and Analysis section with management and, based on such review
and discussion, recommended to our Board of Directors that it be included
in this Annual Report on Form 10-K.
March 6, 2007 Compensation Committee:
W. Brent LaGere
Mark T. Paden
PAGE 43
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
All of the common stock of Chandler USA, its sole class of common
equity, is owned by Chandler Insurance.
The following table sets forth the number and percentage of outstanding
shares of each class of the capital stock of Chandler Insurance that, as of
February 28, 2007, are beneficially owned by (i) each director of Chandler
USA and Chandler Insurance, (ii) each of the named executive officers and
(iii) all current directors and executive officers as a group:
BENEFICIAL OWNERSHIP
----------------------------------------------------------
TYPE OF CAPITAL SHARES NUMBER OF
NAME OF DIRECTOR OR EXECUTIVE OFFICER OF CHANDLER INSURANCE CAPITAL SHARES (1) PERCENT (2)
- ---------------------------------------------------- ------------------------- ------------------ -----------
W. Brent LaGere (3) ................................ Class A Common Shares 500,661 80.0%
Series A Preferred Shares 75,152 19.9%
Mark T. Paden ...................................... Class A Common Shares 125,165 20.0%
Series A Preferred Shares 17,610 4.7%
Richard L. Evans ................................... Series A Preferred Shares 27,272 7.2%
Series B Preferred Shares 32,250 13.5%
R. Patrick Gilmore ................................. Series B Preferred Shares 11,000 4.6%
Mark C. Hart ....................................... Series A Preferred Shares 3,528 0.9%
Robert L. Rice ..................................... - - -%
W. Scott Martin .................................... Series C Preferred Shares 19,000 3.0%
William T. Keele (4) ............................... Series C Preferred Shares 122,417 19.1%
All directors and officers as a group (8 persons) .. Class A Common Shares 625,826 100.0%
Series A Preferred Shares 123,562 32.7%
Series B Preferred Shares 43,250 18.1%
Series C Preferred Shares 141,417 22.0%
- -------------------------------------------------------
<FN>
(1) The rules of the SEC provide that, for the purposes hereof, a person is considered the "beneficial owner"
of shares with respect to which the person, directly or indirectly, has or shares the voting or investment
power, irrespective of his economic interest in the shares. Unless otherwise noted, each person identified
possesses sole voting and investment power over the shares listed, subject to community property laws. The
Preferred Shares of Chandler Insurance have no voting rights. The Series A Preferred Shares of Chandler
Insurance are convertible to Class A Common Shares of Chandler Insurance.
(2) Based on 625,826 Class A Common Shares of Chandler Insurance, 378,328 Series A Preferred Shares of Chandler
Insurance, 238,593 Series B Preferred Shares of Chandler Insurance and 642,069 Series C Preferred Shares of
Chandler Insurance outstanding on February 28, 2007.
(3) Includes (i) 348,390 Class A Common Shares of Chandler Insurance owned by the W. Brent LaGere Irrevocable
Trust (the "LaGere Trust") and (ii) 22,500 Class A Common Shares of Chandler Insurance owned by W&L Holding
Corp. ("W&L Holding"), a corporation 100% of which is owned by the LaGere Trust. Mr. LaGere holds an
irrevocable proxy for the Class A Common Shares owned by the LaGere Trust and W&L Holding. Mr. LaGere
disclaims beneficial ownership of the shares held by the LaGere Trust and W&L Holding. The business address
of Mr. LaGere is 1010 Manvel Avenue, Chandler, Oklahoma 74834.
(4) Includes 63,787 Series C Preferred Shares of Chandler Insurance held by the Keele Family Ltd. Partnership,
4,062 shares held by Mr. Keele's wife and 23,911 shares held by Mr. Keele's children. Mr. Keele disclaims
beneficial ownership of the shares owned by his wife and children.
PAGE 44
SHAREHOLDERS HOLDING OVER FIVE PERCENT
Listed below are persons, other than those listed previously, who are
known by Chandler USA to own beneficially more than 5% of Chandler
Insurance's Class A Common Shares as of February 28, 2007. Except as
otherwise indicated, each of the persons named below has sole voting and
investment power with respect to the common shares beneficially owned.
BENEFICIAL OWNERSHIP
------------------------------------
NAME OF SHAREHOLDER NUMBER OF SHARES (1) PERCENT (2)
- --------------------------------------------------------------- ------------------- ---------------
Malinda K. LaGere Laird, Matthew C. LaGere and Lance A. LaGere,
Successor Co-Trustees of the W. Brent LaGere Irrevocable Trust
1010 Manvel Avenue, Chandler, Oklahoma 74834 ................. 370,890 (3) 59.3%
- ----------------------------------------------------------------
<FN>
(1) The rules of the SEC provide that, for the purposes hereof, a person is considered the "beneficial
owner" of shares with respect to which the person, directly or indirectly, has or shares the voting
or investment power, irrespective of his economic interest in the shares. Unless otherwise noted,
each person identified possesses sole voting and investment power over the shares listed, subject
to community property laws.
(2) Based on 625,826 Class A Common Shares of Chandler Insurance outstanding on February 28, 2007.
(3) Includes 370,890 Class A Common Shares of Chandler Insurance held by the LaGere Trust, of which
22,500 Class A Common Shares are directly owned by W&L Holding, which is 100% owned by the LaGere
Trust. Mr. LaGere holds an irrevocable proxy for the Class A Common Shares owned by the LaGere
Trust and W&L Holding.
OTHER MATTERS REGARDING BENEFICIAL OWNERSHIP
For purposes of this report, unless otherwise indicated, Chandler USA
has assumed that the following persons are affiliates: an entity's
executive officers and directors or its managing partners, persons holding
more than 10% of an entity, and those persons who are controlling, controlled
by, or under common control with such officers, directors, managing partners,
or shareholders.
Statements of percentages of ownership are made based upon pertinent
reporting requirements and guidelines specifically applicable to this report
on Form 10-K. Determination of voting power under Chandler USA's Articles of
Incorporation or applicable insurance holding company laws may be at variance
with the above stated percentages.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE.
Transactions with related persons are reviewed and approved by the Board
of Directors of Chandler USA or, in certain situations, by the Board of
Directors of one of its subsidiary companies.
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 three years, and during March
2007 the lease was extended for an additional three years. See Note 11 to
Consolidated Financial Statements for additional information. The bank
that participated in the sale and leaseback transaction established a
letter of credit in the amount of $500,000 on behalf of Chandler USA for the
benefit of Brown & Brown, Inc. as security in connection with the sale of a
subsidiary. Chandler USA paid a fee of $5,000 during 2004 to the bank for
issuing the letter of credit. This letter of credit expired on December 31,
2005. W. Scott Martin, a director of NAICO and Chandler USA, is an officer
and director of the bank that participated in these transactions, and is also
a significant shareholder of the bank's holding company. Mr. Martin is also
a director of the bank that Chandler USA and its subsidiaries use as their
principal disbursement bank, and is a significant shareholder of the bank's
holding company. The balance maintained by Chandler USA and each subsidiary
is fully insured by the Federal Deposit Insurance Corporation, and Chandler
USA and its subsidiaries pay customary service charges to the bank for the
services provided.
During the second quarter of 2006, CIMI purchased two limited
partnership units in Basin Drilling #2 LP for $2,000, and purchased 8%
cumulative subordinated debentures in the amount of $500,000. The timing
of payment of interest and principal on the debentures is subject to
various restrictions contained in the cumulative subordinated debenture
note. The purpose of the partnership is to own and operate an oil and gas
drilling rig. CIMI financed the purchase with a $500,000 variable rate bank
loan. Principal and interest payments are due on the bank loan in five
quarterly installments beginning September 1, 2006. Interest is payable at
1% over New York Prime, which was 9.25% at December 31, 2006. The
partnership is managed by Basin Management, LLC ("BMLLC") who is the General
Partner. W. Scott Martin, a director of NAICO and Chandler USA, is the
Manager for BMLLC, and is also a director of the bank and a significant
shareholder of the bank holding company that provided the bank loan described
above.
PAGE 45
Chandler USA leases a rural property from Davenport Farms, Inc.
("Davenport Farms"), a corporation owned by W. Brent LaGere, Richard L. Evans
and Mark T. Paden. Chandler USA has placed three mobile homes on the
property, drilled a water well connected to the mobile homes and made other
smaller improvements to the property. Its personnel maintain these
improvements. These mobile homes and the property provide hunting, fishing,
lodging, dining and other outdoor recreational activities for the
entertainment of customers and business associates of Chandler USA and/or
its subsidiaries. Chandler USA pays no rent to Davenport Farms but
reimburses it for one-half of the utilities and for hunting supplies.
Chandler USA has also agreed to indemnify Davenport Farms for claims arising
out of its use of the property. Chandler USA retains the right to remove
all structures located upon the property when the lease terminates. In
2004, 2005 and 2006, Chandler USA incurred approximately $353,000, $313,000
and $308,000, respectively, in expenses associated with its use of this
property, including $14,000, $10,000 and $11,000 for reimbursement of
certain expenses, such as utility and similar expenses, for the years 2004,
2005 and 2006, respectively.
DIRECTOR INDEPENDENCE
Chandler USA is a privately held corporation with only debt securities
listed on the American Stock Exchange ("AMEX"). The AMEX requires that a
majority of the directors be "independent directors" as defined in the AMEX
Company Guide. Chandler USA has relied upon an exception to this requirement
which is provided for companies listing only debt securities. The Board of
Directors has determined that Messrs. Rice, Martin and Keele are independent
directors.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
AUDIT FEES
The aggregate audit fees billed or to be billed by Tullius Taylor
Sartain & Sartain LLP for the audit of Chandler USA's annual financial
statements and review of financial statements included in Chandler USA's
Form 10-Q and services that are normally provided by the accountant in
connection with statutory and regulatory filings or engagements were
approximately $155,000, $167,100 and $178,900 for the years ended December
31, 2004, 2005 and 2006, respectively.
AUDIT-RELATED FEES
The aggregate fees billed for professional services rendered by
Tullius Taylor Sartain & Sartain LLP for audit related services rendered
in connection with the audits of employee benefit plans and consultation
on accounting standards or transactions were $18,150, $28,450 and $21,000
for the years ended December 31, 2004, 2005 and 2006, respectively.
TAX FEES
The aggregate fees billed or to be billed for professional services
rendered by Tullius Taylor Sartain & Sartain LLP for tax compliance, tax
advice and tax planning were $17,700, $23,650 and $20,750 for the years
ended December 31, 2004, 2005 and 2006, respectively.
ALL OTHER FEES
The aggregate fees billed by Tullius Taylor Sartain & Sartain LLP
for professional services other than those reported in the categories
above were $500 for the year ended December 31, 2005. There were no other
fees billed by Tullius Taylor Sartain & Sartain LLP for the years ended
December 31, 2004 and 2006.
POLICY ON PRE-APPROVAL OR RETENTION OF INDEPENDENT AUDITORS
All audit and permitted non-audit services for which Chandler USA
engages Tullius Taylor Sartain & Sartain LLP require pre-approval by
Chandler USA's Audit Committee. The percentage of Audit-Related Fees, Tax
Fees and All Other Fees out of all fees paid to Tullius Taylor Sartain &
Sartain LLP was 18.8%, 23.9% and 18.9% for the years ended December 31,
2004, 2005 and 2006, respectively.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
(a) 1. FINANCIAL STATEMENTS. The consolidated balance sheets of
Chandler USA and its subsidiaries as of December 31, 2005 and
2006, and the related consolidated statements of operations,
comprehensive income, shareholder's equity and cash flows for
each of the three years in the period ended December 31, 2006,
together with the related notes thereto and the report of
Tullius Taylor Sartain & Sartain LLP, independent auditors on
such financial statements, are filed as a part of this Form
10-K. See accompanying Index on page F-1.
PAGE 46
2. FINANCIAL STATEMENT SCHEDULES. The financial statement
schedules listed in the accompanying index to consolidated
financial statements and schedules are filed as part of this
Form 10-K. All other schedules have been omitted since the
required information is not applicable or is not present in
amounts sufficient to require submission of the schedule or
because the information is included in the consolidated
financial statements or the notes thereon.
3. EXHIBITS.
3.1 Certificate of Incorporation. (1)
3.2 Bylaws, as amended. (1)
4.1 Form of Indenture entered into by and between Chandler
(U.S.A.), Inc. as issuer and U.S. Trust of Texas, N.A.
as trustee. (1)
4.2 First Amendment to Indenture effective May 13, 2003
constituting the First Amendment to the Indenture dated
as of July 16, 1999, between Chandler (U.S.A.), Inc.,
and The Bank of New York Trust Company of Florida, N.A.
as successor trustee to U.S. Trust Company of Texas,
N.A., as Trustee regarding the 8.75% senior debentures
due 2014 issued by Chandler (U.S.A.), Inc. (3)
4.3 Second Amendment to Indenture effective December 1, 2003
constituting the Second Amendment to the Indenture dated
as of July 16, 1999, between Chandler (U.S.A.), Inc.,
and The Bank of New York Trust Company of Florida, N.A.
as successor trustee to U.S. Trust Company of Texas,
N.A., as Trustee regarding the 8.75% senior debentures
due 2014 issued by Chandler (U.S.A.), Inc. (5)
10.1 Employment Agreement, effective as of October 28,
1988, by and between Chandler (U.S.A.), Inc. and Brent
LaGere. (1)
10.2 Employment Agreement, effective as of October 28, 1988,
by and between Chandler (U.S.A.), Inc., and Brenda B.
Watson (formerly Brenda B. Pair). (1)
10.3 Amendment to Employment Agreement, effective as of
January 1, 1999, by and between Chandler (U.S.A.), Inc.
and Brenda B. Watson. (1)
10.4 Intercompany Credit Agreement effective as of January
1, 2001, by and between Chandler (U.S.A.), Inc. and
Chandler Insurance (Barbados), Ltd. (2)
10.5 Stock Purchase Agreement effective as of December 1,
2002, by and among Brown & Brown, Inc., Chandler
(U.S.A.), Inc., Chandler Insurance Company, Ltd.,
National American Insurance Company, W. Brent LaGere
and Mark T. Paden. (3)
10.6 Amended and Restated Declaration of Trust of Chandler
Capital Trust I dated as of May 22, 2003 among Chandler
(U.S.A.), Inc., as sponsor, Wilmington Trust Company,
as Delaware trustee, Wilmington Trust Company, as
institutional trustee, and W. Brent LaGere, Mark T.
Paden and Mark C. Hart, as administrators. (4)
10.7 Indenture, dated as of May 22, 2003 among Chandler
(U.S.A.), Inc., as issuer, and Wilmington Trust
Company, as trustee. (4)
10.8 Guarantee Agreement, dated as of May 22, 2003 between
Chandler (U.S.A.), Inc., as guarantor, and Wilmington
Trust Company, as guarantee trustee. (4)
10.9 Capital Securities Subscription Agreement dated as of
May 13, 2003 among Chandler (U.S.A.), Inc. and Chandler
Capital Trust I, together as offerors, and InCapS
Funding I, Ltd., as purchaser. (4)
10.10 Placement Agreement dated May 13, 2003 among Chandler
(U.S.A.), Inc. and Chandler Capital Trust I, together
as offerors, and Sandler O'Neill & Partners, L.P., as
placement agent. (4)
10.11 Amended and Restated Declaration of Trust of Chandler
Capital Trust II dated as of December 16, 2003 among
Chandler (U.S.A.), Inc., as sponsor, Wilmington Trust
Company, as Delaware trustee, Wilmington Trust Company,
as institutional trustee, and W. Brent LaGere, Mark T.
Paden and Mark C. Hart, as administrators. (6)
PAGE 47
10.12 Indenture, dated as of December 16, 2003 among Chandler
(U.S.A.), Inc., as issuer, and Wilmington Trust Company,
as trustee. (6)
10.13 Guarantee Agreement, dated as of December 16, 2003
between Chandler (U.S.A.), Inc., as guarantor, and
Wilmington Trust Company, as guarantee trustee. (6)
10.14 Capital Securities Subscription Agreement dated as of
December 4, 2003 among Chandler (U.S.A.), Inc. and
Chandler Capital Trust II, together as offerors, and
InCapS Funding II, Ltd., as purchaser. (6)
10.15 Placement Agreement dated December 4, 2003 among
Chandler (U.S.A.), Inc. and Chandler Capital Trust II,
together as offerors, and Sandler O'Neill & Partners,
L.P., as placement agent. (6)
14.1 Code of Ethics. (6)
21.1 Subsidiaries of the registrant.
31.1 Rule 13a-14(a)/15d-14(a) Certifications.
32.1 Section 1350 Certifications
- ----------------------------
(1) Previously filed as an exhibit to Registration No.
333-76393 on Form S-1 and incorporated herein by
reference.
(2) Previously filed as an exhibit to Chandler USA's Annual
Report on Form 10-K for the year ended December 31,
2001 and incorporated herein by reference.
(3) Previously filed as an exhibit to Chandler USA's Annual
Report on Form 10-K for the year ended December 31,
2002 and incorporated herein by reference.
(4) Previously filed as an exhibit to Chandler USA's
Quarterly Report on Form 10-Q for the quarter ended
June 30, 2003 and incorporated herein by reference.
(5) Previously filed as an exhibit to Chandler USA's current
report on Form 8-K dated December 1, 2003 and
incorporated herein by reference.
(6) Previously filed as an exhibit to Chandler USA's Annual
Report on Form 10-K for the year ended December 31,
2003 and incorporated herein by reference.
Copies of the foregoing exhibits filed with this Form 10-K or incorporated by
reference are available from Chandler USA upon written request and payment of
a reasonable copying fee.
PAGE 48
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) 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.
CHANDLER (U.S.A.), INC.
Date: March 6, 2007 By: /s/ W. Brent LaGere
----------------------------------------------------
W. Brent LaGere
Chairman of the Board and Chief Executive Officer
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934,
THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
Date: March 6, 2007 /s/ W. Brent LaGere
----------------------------------------------------
W. Brent LaGere, Chairman of the Board,
Chief Executive Officer and Director
(Principal Executive Officer)
Date: March 6, 2007 /s/ Mark T. Paden
----------------------------------------------------
Mark T. Paden, President and Director
Date: March 6, 2007 /s/ Mark C. Hart
----------------------------------------------------
Mark C. Hart, Sr. Vice President - Finance,
Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer)
Date: March 6, 2007 /s/ Richard L. Evans
----------------------------------------------------
Richard L. Evans, Senior Vice President and Director
Date: March 6, 2007 /s/ R. Patrick Gilmore
----------------------------------------------------
R. Patrick Gilmore, Senior Vice President,
Secretary, General Counsel and Director
Date: March 6, 2007 /s/ Robert L. Rice
----------------------------------------------------
Robert L. Rice, Director
Date: March 6, 2007 /s/ W. Scott Martin
----------------------------------------------------
W. Scott Martin, Director
Date: March 6, 2007 /s/ William T. Keele
----------------------------------------------------
William T. Keele, Director
PAGE F-1
CHANDLER (U.S.A.), INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
PAGES
-----------------
FINANCIAL STATEMENTS
Consolidated Balance Sheets as of December 31, 2005 and 2006 ................................. F-2
Consolidated Statements of Operations for the years ended
December 31, 2004, 2005 and 2006 ......................................................... F-3
Consolidated Statements of Comprehensive Income for the years ended
December 31, 2004, 2005 and 2006 ......................................................... F-4
Consolidated Statements of Cash Flows for the years ended
December 31, 2004, 2005 and 2006 ......................................................... F-5
Consolidated Statements of Shareholder's Equity for the years ended
December 31, 2004, 2005 and 2006 ......................................................... F-6
Notes to Consolidated Financial Statements ................................................... F-7 through F-25
Report of Independent Registered Public Accounting Firm on Consolidated Financial Statements
and Financial Statement Schedules ........................................................... F-26
SCHEDULES
I Summary of Investments - Other Than Investments in Related Parties ................... F-27
II Condensed Financial Information of Registrant ........................................ F-28 through F-30
III Supplementary Insurance Information .................................................. F-31
IV Reinsurance .......................................................................... F-32
V Valuation and Qualifying Accounts .................................................... F-33
VI Supplemental Information (for property-casualty insurance underwriters) .............. F-34
PAGE F-2
CHANDLER (U.S.A.), INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands except share amounts)
DECEMBER 31,
-----------------------
2005 2006
---------- ----------
ASSETS
Investments
Fixed maturities available for sale, at fair value
Restricted (amortized cost $11,789 and $19,830 in 2005 and 2006, respectively) .......... $ 11,330 $ 19,151
Unrestricted (amortized cost $61,954 and $48,557 in 2005 and 2006, respectively) ........ 60,405 47,228
Equity securities at fair value (cost $8,558 and $1,587 in 2005 and 2006, respectively) .. 9,071 1,921
---------- ----------
Total investments ....................................................................... 80,806 68,300
Cash and cash equivalents ($209 and $450 restricted in 2005 and 2006, respectively) ....... 5,510 21,403
Accrued investment income ................................................................. 887 5,022
Premiums receivable, less allowance for non-collection
of $223 and $170 at 2005 and 2006, respectively .......................................... 28,346 31,008
Reinsurance recoverable on paid losses .................................................... 2,875 1,087
Reinsurance recoverable on unpaid losses, less allowance for non-collection
of $174 and $130 at 2005 and 2006, respectively .......................................... 54,708 25,588
Reinsurance recoverable on unpaid losses from related parties ............................. 14,284 15,584
Prepaid reinsurance premiums .............................................................. 9,763 7,603
Prepaid reinsurance premiums to related parties ........................................... 12,247 13,506
Deferred policy acquisition costs ......................................................... 1,225 845
Property and equipment, net ............................................................... 8,640 8,457
Amounts due from related parties .......................................................... 9,360 9,584
State insurance licenses, net ............................................................. 3,745 3,745
Other assets .............................................................................. 12,663 11,040
---------- ----------
Total assets .............................................................................. $ 245,059 $ 222,772
========== ==========
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Unpaid losses and loss adjustment expenses ............................................... $ 109,541 $ 83,253
Unearned premiums ........................................................................ 55,034 53,217
Policyholder deposits .................................................................... 5,684 7,663
Accrued taxes and other payables ......................................................... 5,221 5,119
Premiums payable ......................................................................... 2,181 1,955
Premiums payable to related parties ...................................................... 113 1,002
Debentures ............................................................................... 6,979 6,979
Junior subordinated debentures issued to affiliated trusts ............................... 20,620 20,620
---------- ----------
Total liabilities ....................................................................... 205,373 179,808
---------- ----------
Commitments and contingencies (Notes 10 and 11)
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 ...................................................................... (19,913) (16,517)
Accumulated other comprehensive income (loss):
Unrealized loss on investments available for sale, net of deferred income taxes ......... (987) (1,105)
---------- ----------
Total shareholder's equity ................................................................. 39,686 42,964
---------- ----------
Total liabilities and shareholder's equity ................................................. $ 245,059 $ 222,772
========== ==========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
PAGE F-3
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands)
YEAR ENDED DECEMBER 31,
--------------------------------------
2004 2005 2006
------------ ------------ ------------
Premiums and other revenues
Direct premiums written and assumed .................................... $ 121,651 $ 120,344 $ 113,043
Reinsurance premiums ceded ............................................. (21,132) (23,060) (21,098)
Reinsurance premiums ceded to related parties .......................... (30,055) (27,158) (27,156)
------------ ------------ ------------
Net premiums written and assumed ..................................... 70,464 70,126 64,789
Decrease (increase) in unearned premiums ............................... (6,422) (4,066) 915
------------ ------------ ------------
Net premiums earned .................................................. 64,042 66,060 65,704
Investment income, net .................................................. 3,186 2,798 9,801
Interest income, net from related parties ............................... 491 670 792
Realized investment gains, net .......................................... 652 383 745
Other income ............................................................ 640 251 317
------------ ------------ ------------
Total premiums and other revenues .................................... 69,011 70,162 77,359
------------ ------------ ------------
Operating costs and expenses
Losses and loss adjustment expenses, net of amounts ceded
to related parties of $15,587, $13,200 and $14,007
in 2004, 2005 and 2006, respectively ................................. 53,781 37,324 45,473
Policy acquisition costs, net of ceding commissions received
from related parties of $11,550, $10,498 and $10,445
in 2004, 2005 and 2006, respectively ................................. 11,039 10,671 11,666
General and administrative expenses .................................... 12,380 12,749 12,469
Interest expense ....................................................... 2,397 2,535 2,690
------------ ------------ ------------
Total operating costs and expenses ................................... 79,597 63,279 72,298
------------ ------------ ------------
Income (loss) before income taxes ....................................... (10,586) 6,883 5,061
Federal income tax benefit (provision) .................................. 3,582 (2,450) (1,665)
------------ ------------ ------------
Income (loss) ........................................................... $ (7,004) $ 4,433 $ 3,396
============ ============ ============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
PAGE F-4
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in thousands)
YEAR ENDED DECEMBER 31,
--------------------------------------
2004 2005 2006
------------ ------------ ------------
Net income (loss) ............................................................ $ (7,004) $ 4,433 $ 3,396
------------ ------------ ------------
Other comprehensive loss, before income tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period ................... (322) (1,040) 566
Less: Reclassification adjustment for gains included in net income (loss).. (652) (383) (745)
------------ ------------ ------------
Other comprehensive loss, before income tax .................................. (974) (1,423) (179)
Income tax benefit related to items of other
comprehensive loss ......................................................... 331 484 61
------------ ------------ ------------
Other comprehensive loss, net of income tax .................................. (643) (939) (118)
------------ ------------ ------------
Comprehensive income (loss) .................................................. $ (7,647) $ 3,494 $ 3,278
============ ============ ============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
PAGE F-5
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
YEAR ENDED DECEMBER 31,
--------------------------------------
2004 2005 2006
------------ ------------ ------------
OPERATING ACTIVITIES
Net income (loss) ...................................................... $ (7,004) $ 4,433 $ 3,396
Add (deduct):
Adjustments to reconcile net income (loss) to cash
provided by (applied to) operating activities:
Realized investment gains, net ....................................... (652) (383) (745)
Gain on retirement of debentures ..................................... (36) - -
Net (gains) losses on sale of property and equipment ................. (370) (2) 20
Amortization and depreciation ........................................ 1,525 1,486 1,379
Provision for non-collection of premiums ............................. 42 176 80
Provision for non-collection of reinsurance recoverables ............. 282 108 97
Net change in non-cash balances relating to operating activities:
Accrued investment income ........................................... (86) 28 (4,135)
Premiums receivable ................................................. (2,547) (5,713) (2,742)
Reinsurance recoverable on paid losses .............................. 6,439 (875) 1,647
Reinsurance recoverable on paid losses from related parties ......... 188 83 -
Reinsurance recoverable on unpaid losses ............................ (1,551) (4,263) 29,164
Reinsurance recoverable on unpaid losses from related parties ....... (3,420) (1,127) (1,300)
Prepaid reinsurance premiums ........................................ 5,432 74 2,160
Prepaid reinsurance premiums to related parties ..................... (2,794) 68 (1,259)
Deferred policy acquisition costs ................................... 108 (1,168) 380
Other assets ........................................................ (2,704) 2,676 2,129
Unpaid losses and loss adjustment expenses .......................... 20,465 1,308 (26,288)
Unearned premiums ................................................... 3,784 3,925 (1,817)
Policyholder deposits ............................................... 105 772 1,979
Accrued taxes and other payables .................................... 329 (357) (441)
Premiums payable .................................................... 2,691 (1,493) (226)
Premiums payable to related parties ................................. - 113 889
------------ ------------ ------------
Cash provided by (applied to) operating activities ................... 20,226 (131) 4,367
------------ ------------ ------------
INVESTING ACTIVITIES
Unrestricted fixed maturities available for sale:
Purchases ............................................................. (38,927) (6,158) (995)
Sales ................................................................. 23,772 2,091 -
Maturities ............................................................ 4,311 1,770 5,809
Equity securities available for sale:
Purchases ............................................................. (8,058) (500) (13,620)
Sales ................................................................. 36 380 21,336
Cost of property and equipment purchased ............................... (208) (413) (688)
Proceeds from sale of property and equipment ........................... 85 70 71
Investment in limited partnership ...................................... - - (502)
------------ ------------ ------------
Cash provided by (applied to) investing activities ................... (18,989) (2,760) 11,411
------------ ------------ ------------
FINANCING ACTIVITIES
Payment on retirement of debentures .................................... (226) - -
Debt issue costs ....................................................... (18) - -
Payments and loans from related parties ................................ 4,602 2,513 1,747
Payments and loans to related parties .................................. (5,851) (982) (1,971)
Bank loan proceeds ..................................................... - - 500
Payments on bank loan .................................................. - - (161)
------------ ------------ ------------
Cash provided by (applied to) financing activities ................... (1,493) 1,531 115
------------ ------------ ------------
Increase (decrease) in cash and cash equivalents during the period ..... (256) (1,360) 15,893
Cash and cash equivalents at beginning of period ....................... 7,126 6,870 5,510
------------ ------------ ------------
Cash and cash equivalents at end of period ............................. $ 6,870 $ 5,510 $ 21,403
============ ============ ============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
PAGE F-6
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY
(Amounts in thousands)
Accumulated
other Total
Common Paid-in Accumulated comprehensive shareholder's
stock surplus deficit income (loss) equity
----------- ----------- ----------- ------------- -------------
Balance, January 1, 2004 ......... $ 2 $ 60,584 $ (17,342) $ 595 $ 43,839
Net loss ......................... - - (7,004) - (7,004)
Change in unrealized gain on
investments available for
sale, net of income tax ........ - - - (643) (643)
----------- ----------- ----------- ------------- -------------
Balance, December 31, 2004 ....... 2 60,584 (24,346) (48) 36,192
----------- ----------- ----------- ------------- -------------
Net income ....................... - - 4,433 - 4,433
Change in unrealized loss on
investments available for
sale, net of income tax ........ - - - (939) (939)
----------- ----------- ----------- ------------- -------------
Balance, December 31, 2005 ....... 2 60,584 (19,913) (987) 39,686
----------- ----------- ----------- ------------- -------------
Net income ....................... - - 3,396 - 3,396
Change in unrealized loss on
investments available for
sale, net of income tax ........ - - - (118) (118)
----------- ----------- ----------- ------------- -------------
Balance, December 31, 2006 ....... $ 2 $ 60,584 $ (16,517) $ (1,105) $ 42,964
=========== =========== =========== ============= =============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
PAGE F-7
CHANDLER (U.S.A.), INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2005 AND 2006
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
(a) BASIS OF PRESENTATION
Chandler (U.S.A.), Inc. ("Chandler USA") is a holding company
organized and domiciled in Oklahoma. Chandler USA's wholly owned
subsidiaries are engaged in various property and casualty insurance
operations. The insurance products offered by Chandler USA through
its subsidiary, National American Insurance Company ("NAICO"),
include property and casualty insurance products primarily for
businesses in various industries, political subdivisions,
homeowners insurance in Texas and surety bonds for small contractors
in the United States of America ("U.S."). The business is
conducted through individual independent insurance agencies and
underwriting managers, primarily in the Southwest and Midwest areas
of the U.S. Chandler Insurance Managers, Inc. ("CIMI") is a wholly
owned subsidiary of Chandler USA and is an underwriting manager and
wholesaler that offers multiple insurance products for businesses in
various industries and political subdivisions.
The consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the
United States of America ("GAAP"). The preparation of the financial
statements requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ
significantly from those estimates. Certain reclassifications of
prior years have been made to conform to the 2006 presentation.
(b) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of
Chandler USA and all wholly owned subsidiaries that meet
consolidation requirements including NAICO and CIMI. All
significant intercompany accounts and transactions have been
eliminated in consolidation.
(c) IMPAIRMENT OF LONG-LIVED ASSETS
Chandler USA periodically evaluates the carrying value of
long-lived assets to be held and used when changes in events and
circumstances warrant such a review. The carrying value of a
long-lived asset is considered impaired when the separately
identifiable anticipated undiscounted cash flow from such asset is
less than its carrying value. In that event, a loss is recognized
based on the amount by which the carrying value exceeds the fair
value of the long-lived asset. Fair value is determined primarily
using the anticipated cash flows discounted at a rate commensurate
with the risk involved. Losses on long-lived assets to be disposed
of are determined in a similar manner, except that fair values are
reduced for disposal costs.
(d) REVENUE RECOGNITION
Premiums are generally recognized as earned on a pro rata basis
over the policy period, which is in proportion to the insurance
protection provided. The portion of premiums that will be earned
in the future are deferred and reported as unearned premiums.
Amounts recorded for ceded reinsurance premiums are reported as
prepaid reinsurance premiums and amortized over the remaining
contract period in proportion to the amount of the insurance
protection provided. Commission revenues are generally recognized
when coverage is effective or premiums are billed, whichever is
later. Commission revenues are reported net of commissions paid
to producing agents.
(e) PREMIUMS RECEIVABLE
Premiums receivable are presented net of valuation allowances
for estimated uncollectible amounts. Chandler USA determines the
allowance for non-collection by regularly evaluating individual
agent accounts and balances due from insureds, considering their
financial condition and other appropriate factors. Such accounts
are considered past due based on contractual terms for the agent
or insured. Premiums receivable are written off when deemed
uncollectible. Recoveries of accounts previously written off are
recorded when received.
PAGE F-8
(f) UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
Losses and loss adjustment expenses are charged to income as
incurred. The reserve for unpaid losses and loss adjustment
expenses represents the accumulation of estimates for reported
losses and includes provisions for losses incurred but not reported
based on data available at this time. The methods of determining
such estimates and establishing resulting reserves are periodically
reviewed and updated, and adjustments therefrom are necessary to
maintain an adequate reserve for unpaid losses and loss adjustment
expenses. As more fully explained in Note 3, such estimates are
management's best estimates of the expected values. The actual
results may vary from these values because the evaluation of losses
is inherently subjective and susceptible to significant changing
factors.
(g) DEFERRED POLICY ACQUISITION COSTS
Policy acquisition costs that vary with and are primarily
related to the acquisition of new and renewal business (such as
premium taxes, agent commissions, commissions received from
reinsurers and a portion of other underwriting expenses) 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. Certain policy acquisition
costs, such as policyholder dividends, are expensed directly.
(h) PROPERTY AND EQUIPMENT
Real estate and improvements and other property and equipment
are stated at cost and depreciated using the straight-line method
over their useful lives which range from 3 to 31 years. Property
and equipment consisted of the following at December 31:
2005 2006
---------- ----------
(In thousands)
Real estate and improvements ... $ 11,756 $ 11,889
Other property and equipment ... 8,468 8,408
---------- ----------
20,224 20,297
Accumulated depreciation ....... (11,584) (11,840)
---------- ----------
$ 8,640 $ 8,457
========== ==========
Depreciation expense was approximately $894,000, $815,000 and
$780,000 for 2004, 2005 and 2006, respectively.
(i) INTANGIBLE ASSETS
Intangible assets are stated at cost less accumulated
amortization. Prior to 2002, the cost of state insurance licenses
acquired was amortized over 40 years using the straight-line
method. Effective January 1, 2002, the state insurance licenses
are no longer amortized since they were determined to have
indefinite lives but are reviewed at least annually for impairment.
Chandler USA completed the required impairment tests during 2005
and 2006 and concluded that there has not been an impairment loss
since the fair values exceeded their carrying values. The fair
values were determined based on the present value of projected
future net cash flows. Intangible assets included the following
at December 31:
2005 2006
---------- ----------
(In thousands)
State insurance licenses ....... $ 5,991 $ 5,991
Accumulated amortization ....... (2,246) (2,246)
---------- ----------
$ 3,745 $ 3,745
========== ==========
(j) POLICYHOLDER DEPOSITS
NAICO requires certain policyholders to pay a deposit at inception
of coverage to secure payment of future premiums and deductibles on
claims incurred. It is expressly agreed between NAICO and the
policyholder that the funds will be used by NAICO only in the event
the policyholder fails to pay any premiums, deductibles or other
charges when due. NAICO has established a liability for these
deposits in an amount equal to that due the policyholders based on
insurance premiums reported as of the balance sheet date.
PAGE F-9
(k) INVESTMENTS
At the time of purchase, investments in debt securities that
Chandler USA has the positive intent and ability to hold to
maturity are classified as held to maturity and reported at
amortized cost; all other debt securities are reported at fair
value. Investments in debt and equity securities classified as
trading are actively and frequently bought and sold with the
objective of generating income on short-term differences in price.
Realized and unrealized gains and losses on securities classified
as trading account assets are recognized in current operations.
Chandler USA has not classified any investments as trading account
assets. Debt securities not classified as held to maturity or
trading and equity securities are classified as available for sale,
with the related unrealized gains and losses excluded from earnings
and reported net of deferred income tax as other comprehensive
income until realized. Realized gains and losses on sales of
securities are based on the specific identification method.
Declines in the fair value of securities below their carrying value
that are other than temporary are recognized in earnings.
Chandler USA regularly reviews its investment portfolio for
factors that may indicate that a decline in fair value of an
investment is other than temporary. Some factors considered in
evaluating whether or not a decline in fair value is other than
temporary include Chandler USA's ability and intent to retain the
investment for a period of time sufficient to allow for a recovery
in value; the duration and extent to which the fair value has been
less than cost; and the financial condition and prospects of the
issuer.
(l) INCOME TAXES
Chandler USA uses an asset and liability approach for accounting
for income taxes. Deferred income taxes are recognized for the tax
consequences of temporary differences and carryforwards by applying
enacted tax rates applicable to future years to differences between
the financial statement amounts and the tax bases of existing
assets and liabilities. A valuation allowance is established if it
is more likely than not that some portion of the deferred tax asset
will not be realized.
(m) CASH AND CASH EQUIVALENTS
For purposes of the consolidated statements of cash flows,
Chandler USA considers all highly liquid investments with original
maturities of 14 days or less to be cash equivalents. For cash
and cash equivalents, the carrying amount is a reasonable estimate
of fair value.
(n) SUPPLEMENTAL CASH FLOW INFORMATION
Cash payments for interest and income taxes, and noncash
investing activities were as follows:
YEAR ENDED DECEMBER 31,
--------------------------------
2004 2005 2006
---------- ---------- ----------
(In thousands)
Cash payments (refunds) during the year for:
Interest ....................................... $ 2,261 $ 2,447 $ 2,608
Income taxes ................................... - 160 -
Transfers from (to) restricted securities, net ... $ (801) $ (3,429) $ (8,127)
(o) REINSURANCE
Management believes all of NAICO's reinsurance contracts with
reinsurers meet the criteria for risk transfer and the revenue and
cost recognition provisions in order to be accounted for as
reinsurance. As more fully explained in Note 11, reinsurance
contracts do not relieve NAICO from its obligation to policyholders.
In addition, failure of reinsurers to honor their obligations could
result in losses to Chandler USA.
(p) NEW ACCOUNTING STANDARDS
The Financial Accounting Standards Board ("FASB") periodically
issues new accounting standards in a continuing effort to improve
standards of financial accounting and reporting. Chandler USA has
reviewed the recently issued pronouncements and concluded that
the following new accounting standards are applicable to Chandler
USA.
PAGE F-10
In February 2006, the 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 issued 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 liabilities 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.
In July 2006, the FASB issued FASB Interpretation ("FIN") No. 48,
"Accounting for Uncertainty in Income Taxes," which clarifies the
accounting for uncertainty in income taxes recognized in the
financial statements in accordance with SFAS No. 109, "Accounting
for Income Taxes." FIN 48 provides guidance regarding the
recognition, measurement, presentation and disclosure of a tax
position taken or expected to be taken in a tax return as well
as the derecognition of a tax position previously recognized in
the financial statements. Chandler USA will be required to adopt
FIN 48 as of January 1, 2007. Chandler USA does not expect this
statement to have a material impact on its consolidated financial
statements.
In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements," which defines fair value, establishes a framework
for measuring fair value in generally accepted accounting
principles, and expands disclosures about fair value measurements.
The statement does not require new fair value measurements, but
is applied to the extent that other accounting pronouncements
require or permit fair value measurements. The statement
emphasizes that fair value is a market-based measurement that
should be determined based on the assumptions that market
participants would use in pricing an asset or liability.
Companies will be required to disclose the extent to which fair
value is used to measure assets and liabilities, the inputs used
to develop the measurements, and the effect of certain of the
measurements on earnings (or changes in net assets) for the
period. Chandler USA will be required to adopt SFAS No. 157 as
of January 1, 2008. Chandler USA does not expect this statement
to have a material impact on its consolidated financial statements.
In September 2006, the FASB issued SFAS No. 158, "Employers'
Accounting for Defined Benefit Pension and Other Postretirement
Plans - an amendment of FASB Statements No. 87, 88, 106, and
132(R)." This statement requires the company to recognize the
funded status of its defined benefit postretirement plans as an
asset or liability in its financial statements. In addition, the
statement eliminates the use of a measurement date that is
different than the date of the company's year-end financial
statements. Chandler USA will be required to adopt SFAS No. 158
as of December 31, 2006. Chandler USA does not expect this
statement to have a material impact on its consolidated financial
statements.
In February 2007, the FASB issued SFAS No. 159, "The Fair
Value Option for Financial Assets and Financial
Liabilities-Including an amendment of FASB Statement No. 115."
SFAS No. 159 permits companies to choose to measure many
financial instruments and certain other items at fair value at
specified election dates. Upon adoption, an entity shall report
unrealized gains and losses on items for which the fair value
option has been elected in earnings at each subsequent reporting
date. Most of the provisions apply only to entities that elect
the fair value option. However, the amendment to SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity
Securities," applies to all entities with available for sale and
trading securities. SFAS No. 159 is effective as of the
beginning of an entity's first fiscal year that begins after
November 15, 2007. Chandler USA is currently evaluating the
impact that SFAS No. 159 will have, if any, on its consolidated
financial statements.
PAGE F-11
NOTE 2. INVESTMENTS AND INVESTMENT INCOME
Net investment income and realized investment gains are summarized in
the following table. These amounts are net of investment expenses.
YEAR ENDED DECEMBER 31,
--------------------------------
2004 2005 2006
---------- ---------- ----------
(In thousands)
Interest on fixed-maturity investments ................. $ 2,746 $ 2,791 $ 2,829
Interest on cash equivalents ........................... 695 159 574
Dividend income on equity securities ................... 22 135 58
Prejudgment interest related to litigation ............. - - 6,648
Investment expenses .................................... (277) (287) (308)
---------- ---------- ----------
Investment income, net .............................. 3,186 2,798 9,801
---------- ---------- ----------
Realized gains, net - fixed-maturity investments ....... 616 3 -
Realized gains, net - equity securities ................ 36 380 745
---------- ---------- ----------
Realized investments gains, net ..................... 652 383 745
---------- ---------- ----------
$ 3,838 $ 3,181 $ 10,546
========== ========== ==========
During 2006, NAICO recorded $6.6 million of interest income for its
estimate of prejudgment interest on a favorable jury verdict in civil
litigation regarding certain surety bond claims. See Note 10.
Investment expenses include $104,000, $137,000 and $164,000 for the
years ended December 31, 2004, 2005 and 2006, respectively, in expense to
subsidize a premium finance program for certain insureds of NAICO with an
unaffiliated premium finance company.
The amortized cost of fixed maturities or cost of equity securities,
gross unrealized gains or losses, fair value and carrying value of
investments are as follows:
GROSS GROSS
UNREALIZED UNREALIZED FAIR CARRYING
DECEMBER 31, 2005 COST GAINS LOSSES VALUE VALUE
- ------------------------------------------ ---------- ---------- ---------- ---------- ----------
FIXED MATURITIES AVAILABLE FOR SALE: (In thousands)
U.S. Treasury securities and obligations
of U.S. government corporations
and agencies .......................... $ 37,933 $ - $ (904) $ 37,029 $ 37,029
Corporate obligations .................... 27,314 2 (861) 26,455 26,455
Public utilities ......................... 6,479 13 (159) 6,333 6,333
Mortgage-backed securities ............... 2,017 - (99) 1,918 1,918
---------- ---------- ---------- ---------- ----------
$ 73,743 $ 15 $ (2,023) $ 71,735 $ 71,735
========== ========== ========== ========== ==========
EQUITY SECURITIES:
Corporate stock .......................... $ 8,558 $ 513 $ - $ 9,071 $ 9,071
========== ========== ========== ========== ==========
GROSS GROSS
UNREALIZED UNREALIZED FAIR CARRYING
DECEMBER 31, 2006 COST GAINS LOSSES VALUE VALUE
- ------------------------------------------ ---------- ---------- ---------- ---------- ----------
FIXED MATURITIES AVAILABLE FOR SALE: (In thousands)
U.S. Treasury securities and obligations
of U.S. government corporations
and agencies .......................... $ 37,393 $ - $ (946) $ 36,447 $ 36,447
Corporate obligations .................... 23,004 - (825) 22,179 22,179
Public utilities ......................... 6,376 - (163) 6,213 6,213
Mortgage-backed securities ............... 1,614 - (74) 1,540 1,540
---------- ---------- ---------- ---------- ----------
$ 68,387 $ - $ (2,008) $ 66,379 $ 66,379
========== ========== ========== ========== ==========
EQUITY SECURITIES:
Corporate stock .......................... $ 1,587 $ 334 $ - $ 1,921 $ 1,921
========== ========== ========== ========== ==========
At December 31, 2005 and 2006, Chandler USA did not hold any fixed
maturity investments that exceeded 10% of shareholder's equity.
PAGE F-12
The fair value of Chandler USA's investments with sustained gross
unrealized losses at December 31, 2006 is presented below:
LESS THAN 12 MONTHS 12 MONTHS OR LONGER TOTAL
----------------------- ----------------------- ------------------------
UNREALIZED UNREALIZED UNREALIZED
FAIR VALUE LOSSES FAIR VALUE LOSSES FAIR VALUE LOSSES
----------- ---------- ----------- ---------- ----------- ----------
(In thousands)
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies .......... $ 984 $ 11 $ 35,463 $ 935 $ 36,447 $ 946
Corporate securities ................. 2,002 2 20,177 823 22,179 825
Public utilities ..................... 1,701 1 4,512 162 6,213 163
Mortgage-backed securities ........... - - 1,540 74 1,540 74
----------- ---------- ----------- ---------- ----------- ----------
$ 4,687 $ 14 $ 61,692 $ 1,994 $ 66,379 $ 2,008
=========== ========== =========== ========== =========== ==========
The unrealized losses of Chandler USA's fixed maturity investments were
caused by interest rate increases. The contractual terms of those
investments do not permit the issuer to settle the securities at a price
less than the amortized cost of the investment. Chandler USA regularly
reviews its investment portfolio for factors that may indicate that a decline
in fair value of an investment is other than temporary. Based on an
evaluation of the issues, including, but not limited to, Chandler USA's
intentions to sell or ability to hold the investments; the length of time and
amount of the unrealized loss; and the credit ratings of the issuers of the
investments, Chandler USA does not consider these investments to be
other-than-temporarily impaired at December 31, 2006.
Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without
call or prepayment penalties. The maturities of investments in fixed
maturities at December 31, 2006 are shown below:
AVAILABLE FOR SALE
------------------------
AMORTIZED
COST FAIR VALUE
------------ ----------
(In thousands)
Due in one year or less .......................... $ 8,213 $ 8,151
Due after one year through five years ............ 36,739 35,561
Due after five years through ten years ........... 20,119 19,426
Due after ten years .............................. 1,702 1,701
------------ ----------
66,773 64,839
Mortgage-backed securities ....................... 1,614 1,540
------------ ----------
$ 68,387 $ 66,379
============ ==========
Realized gains and losses from sales of investments are shown below:
GROSS REALIZED GAINS GROSS REALIZED LOSSES
-------------------- ---------------------
(In thousands)
FIXED MATURITIES:
2004 ............. $ 693 $ 77
2005 ............. 20 17
2006 ............. - -
EQUITY SECURITIES:
2004 ............. $ 36 $ -
2005 ............. 380 -
2006 ............. 855 110
NAICO is required by several states to deposit securities with state
regulators as a condition of doing business in those states. As of December
31, 2005 and 2006, the carrying value of these deposits totaled approximately
$7.8 million and $7.7 million, respectively. In addition, NAICO has
deposited $11.9 million of cash and investments into a trust account as
collateral for a reinsurance agreement in which NAICO is the assuming
reinsurer.
PAGE F-13
NOTE 3. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
NAICO provides a reserve for estimated losses (reported and unreported)
and loss adjustment expenses based on historical experience and payment
reporting patterns for the type of risk involved. These estimates are based
on data available at the time of the estimate and such estimates are
periodically reviewed by independent professional actuaries. Inherent in
the estimates of the ultimate liability for unpaid claims are expected trends
in claim severity, claim frequency and other factors that may vary as claims
are settled. The amount and uncertainty in the estimates are affected by
such factors as the amount of historical claims experience relative to the
development period for the type of risk, knowledge of the actual facts and
circumstances, and the amount of insurance risk retained. The ultimate cost
of insurance claims can be adversely affected by increased costs such as
medical expenses, repair expenses, costs of providing legal defense for
policyholders, increased jury awards and court decisions and legislation that
define and expand insurance coverage subsequent to the time that the
insurance policy was priced and sold.
Salvage and subrogation recoverables are accrued using the "case basis"
method for large recoverables and statistical estimates based on historical
experience for smaller recoverables. Recoverable amounts deducted from
Chandler USA's net liability for losses and loss adjustment expenses were
approximately $9.6 million and $13.2 million at December 31, 2005 and 2006,
respectively. The increase in estimated recoveries in 2006 is due primarily
to NAICO recording net estimated recoveries totaling $5.6 million related to
a favorable jury verdict in civil litigation regarding certain surety bond
claims during 2006. See Note 10 for more information related to this
litigation. The gross and net estimated recovery deducted from unpaid
losses and loss adjustment expenses related to this litigation at December
31, 2006 is $31.5 million and $10.8 million, respectively. NAICO may or may
not recover the above estimated recoveries and could incur significant costs
in collecting these recoverables.
Although such estimates are management's best estimates of the expected
values, the ultimate liability for unpaid claims may vary from these values.
NAICO does not discount the liability for unpaid losses and loss adjustment
expenses.
The following table sets forth a reconciliation of the beginning and
ending unpaid losses and loss adjustment expenses which are net of
reinsurance deductions.
YEAR ENDED DECEMBER 31,
----------------------------------
2004 2005 2006
---------- ---------- ----------
(In thousands)
Net balance at beginning of year .......................... $ 29,343 $ 44,695 $ 40,549
---------- ---------- ----------
Net losses and loss adjustment expenses incurred related to:
Current year ............................................ 27,436 30,985 41,644
Prior years ............................................. 26,345 6,339 3,829
---------- ---------- ----------
Total ................................................. 53,781 37,324 45,473
---------- ---------- ----------
Net paid losses and loss adjustment expenses related to:
Current year ............................................ (10,222) (11,171) (12,403)
Prior years ............................................. (28,207) (30,299) (31,538)
---------- ---------- ----------
Total ................................................. (38,429) (41,470) (43,941)
---------- ---------- ----------
Net balance at end of year ................................ $ 44,695 $ 40,549 $ 42,081
========== ========== ==========
NAICO has experienced a significant amount of incurred losses related to
prior accident years during the 2004, 2005 and 2006 calendar years. The
adverse loss development is generally the result of ongoing analysis of loss
development trends for both liability and workers compensation lines of
business, and includes provisions for potentially uncollectible reinsurance
and deductibles. NAICO adjusts reserves as experience develops and new
information becomes known. Such adjustments are reflected in the results of
operations in the periods in which the estimates are changed. The adverse
development of losses from prior accident years results in higher calendar
year loss ratios and reduced calendar year operating results.
PAGE F-14
During 2004, NAICO experienced adverse loss development totaling $26.3
million primarily in the standard property and casualty and political
subdivisions programs. This adverse development was due primarily to an
increase in losses in the workers compensation and other liability lines of
business in the 1997-2002 accident years. The adverse development in the
2002 accident year partially offset the reduction in losses for this
accident year that was recorded during 2003. The adverse loss development
included approximately $409,000 for provisions for potentially uncollectible
reinsurance and deductibles. Reserves for unpaid losses and loss adjustment
expenses, net of related reinsurance recoverables, were $44.7 million at
December 31, 2004 compared to $29.3 million at December 31, 2003, an
increase of $15.4 million or 52%.
During 2005, NAICO experienced adverse loss development totaling $6.3
million primarily in the standard property and casualty and political
subdivisions programs. A portion of the adverse development was offset by
favorable development of $1.8 million in the surety bond program, primarily
in accident years 1994 and 2001 that resulted from the estimated recoveries
discussed previously. The adverse development was due primarily to an
increase in losses in the workers compensation, other liability and
automobile liability lines of business in the 2000, 2002 and 2003 accident
years. The adverse loss development included approximately $108,000 for
provisions for potentially uncollectible reinsurance.
During 2006, NAICO experienced adverse loss development totaling $3.8
million primarily in the standard lines program. A portion of the adverse
development was offset by favorable development of $1.0 million in the
surety bond program, primarily in the 2001 accident year, that resulted
from the estimated recoveries discussed previously. The adverse
development was due primarily to an increase in losses in the automobile
liability line of business in the 2005 accident year and in the workers
compensation line of business in the 1997 and 1999 accident years.
NAICO does not ordinarily insure against environmental matters as
that term is commonly used. However, in some cases, regulatory filings
made by NAICO on behalf of an insured can make NAICO directly liable to
the regulatory authority for property damage which could include
environmental pollution. In those cases, NAICO ordinarily has recourse
against the insured or the surety bond principal for amounts paid.
NAICO has insured certain trucking companies and pest control operators
that are required to provide proof of insurance which in some cases
assures payment for clean-up and remediation of damage resulting from
sudden and accidental release or discharge of contaminants or other
substances which may be classified as pollutants. NAICO also provides
surety bonds for construction contractors that use or have control of
such substances and for contractors that remove and dispose of asbestos
as a part of their contractual obligations. NAICO also insures
independent oil and gas producers that may purchase coverage for the
escape of oil, saltwater, or other substances which may be harmful to
persons or property, but may not generally be classified as pollutants.
NAICO maintains claims records which segregate this type of risk for the
purpose of evaluating environmental risk exposure. Based upon the nature
of such lines of business with insureds of NAICO, and current data
regarding the limited severity and infrequency of such matters, it
appears that potential environmental risks are not a significant portion
of claims reserves and therefore would not likely have a material impact,
if any, on the consolidated financial condition, results of operations or
cash flows of Chandler USA.
At this time, NAICO has not received any claims related to the
September 11, 2001 terrorist attacks on the World Trade Center and does
not believe that it has any significant exposure to these and related
losses. While several of NAICO's reinsurers did experience significant
losses related to these attacks, it currently does not appear that these
losses will impair the reinsurers' ability to pay claims.
NOTE 4. DEBENTURES
On July 16, 1999, Chandler USA completed a public offering of $24
million principal amount of senior debentures (the "Debentures") with a
maturity date of July 16, 2014. The Debentures were priced at $1,000 each
with an interest rate of 8.75% and are redeemable by Chandler USA on or
after July 16, 2009 without penalty or premium. The indenture governing
the Debentures was amended during 2003 to clarify that purchases of
Debentures by Chandler USA through private treaty or on the open market
for an agreed price of less than the sum of the principal amount and
accrued interest are not considered to be a redemption of the Debentures,
and that any such Debentures purchased by Chandler USA will be cancelled.
Chandler USA purchased and cancelled $16.7 million and $275,000 principal
amount of the Debentures during 2003 and 2004, respectively, and at
December 31, 2006, there were $6,979,000 principal amount of the
Debentures outstanding. As of December 31, 2006, Chandler USA has
capitalized $247,000 related to debt issuance costs for the Debentures.
These costs are being amortized as interest expense over the term of the
Debentures. When Debentures are purchased and cancelled by Chandler USA,
debt issuance costs are reduced accordingly and reflected in the gain on
retirement of debt which is included in other income in the consolidated
statements of operations. Chandler USA's subsidiaries and affiliates are
not obligated by the Debentures. Accordingly, the Debentures are
effectively subordinated to all existing and future liabilities and
obligations of Chandler USA's existing and future subsidiaries. The
indenture governing the Debentures contains certain restrictive covenants,
including covenants that limit subsidiary debt, issuance or sale of
subsidiary stock, incurring of liens, sale-leaseback transactions for a
period of more than three years, mergers, consolidations and sales of
assets. At December 31, 2006, Chandler USA was in compliance with all
covenants.
PAGE F-15
NOTE 5. TRUST PREFERRED SECURITIES
In May 2003, Chandler USA established Chandler Capital Trust I ("Trust
I") by purchasing all of its common securities for $403,000. Trust I is a
Delaware statutory business trust and is a wholly owned non-consolidated
subsidiary of Chandler USA. On May 22, 2003, Trust I issued $13.0 million
of capital securities (the "Trust I Preferred Securities") to InCapS Funding
I, Ltd., an unaffiliated company established under the laws of the Cayman
Islands, in a private transaction. Trust I used the proceeds from the
issuance to purchase $13,403,000 of 9.75% junior subordinated debentures
(the "Junior Debentures I") of Chandler USA. Distributions on the Junior
Debentures I are payable quarterly at a fixed annual rate of 9.75%. Chandler
USA may defer these payments for up to 20 consecutive quarters, but not
beyond the maturity of the Junior Debentures I, with such deferred payments
accruing interest compounded quarterly. The Junior Debentures I are subject
to a mandatory redemption on May 23, 2033, but they may be redeemed after
five years at a premium of half the fixed rate coupon declining ratably to
par in the 10th year.
The Junior Debentures I are the sole assets of Trust I and Trust I will
distribute any cash payments it receives thereon to the holders of its
preferred and common securities. Distributions on the Trust I Preferred
Securities are payable quarterly at a fixed annual rate of 9.75%. Trust I
may defer these payments for up to 20 consecutive quarters, but not beyond
the maturity of the Trust I Preferred Securities, with such deferred payments
accruing interest compounded quarterly. The Trust I Preferred Securities are
subject to a mandatory redemption on May 23, 2033, but they may be redeemed
after five years at a premium of half the fixed rate coupon declining ratably
to par in the 10th year. All payments by Trust I regarding the Trust I
Preferred Securities are guaranteed by Chandler USA.
In December 2003, Chandler USA established Chandler Capital Trust II
("Trust II") by purchasing all of its common securities for $217,000. Trust
II is a Delaware statutory business trust and is a wholly owned
non-consolidated subsidiary of Chandler USA. On December 16, 2003, Trust
II issued $7.0 million of capital securities (the "Trust II Preferred
Securities") to InCapS Funding II, Ltd., an unaffiliated company established
under the laws of the Cayman Islands, in a private transaction. Trust II
used the proceeds from the issuance to purchase $7,217,000 of floating rate
junior subordinated debentures (the "Junior Debentures II") of Chandler USA.
Distributions on the Junior Debentures II are payable quarterly at a floating
rate of 4.10% over LIBOR (LIBOR is recalculated quarterly and the interest
rate may not exceed 12.5% prior to January 8, 2009). The interest rate was
9.47% at December 31, 2006. Chandler USA may defer these payments for up to
20 consecutive quarters, but not beyond the maturity of the Junior Debentures
II, with such deferred payments accruing interest compounded quarterly. The
Junior Debentures II are subject to a mandatory redemption on January 8,
2034, but they may be redeemed after five years without penalty or premium.
The Junior Debentures II are the sole assets of Trust II and Trust II
will distribute any cash payments it receives thereon to the holders of its
preferred and common securities. Distributions on the Trust II Preferred
Securities are payable quarterly at a floating rate of 4.10% over LIBOR
(LIBOR is recalculated quarterly and the interest rate may not exceed 12.5%
prior to January 8, 2009). The interest rate was 9.47% at December 31,
2006. Trust II may defer these payments for up to 20 consecutive quarters,
but not beyond the maturity of the Trust II Preferred Securities, with such
deferred payments accruing interest compounded quarterly. The Trust II
Preferred Securities are subject to a mandatory redemption on January 8,
2034, but they may be redeemed after five years without penalty or premium.
All payments by Trust II regarding the Trust II Preferred Securities are
guaranteed by Chandler USA.
The sale of the Trust I Preferred Securities and the Trust II Preferred
Securities during 2003 resulted in net proceeds of $19.3 million to Chandler
USA, net of placement costs. As of December 31, 2006, issuance costs in the
amount of $646,000 have been capitalized and are being amortized over the
stated maturity periods of thirty years.
In December 2003, the Financial Accounting Standards Board issued
Revised Interpretation No. 46 ("FIN 46R"), CONSOLIDATION OF VARIABLE
INTEREST ENTITIES. FIN 46R provides guidance on the identification of, and
financial reporting for, entities over which control is achieved through
means other than voting rights. FIN 46R is used to determine whether
consolidation is required or, alternatively, whether the variable-interest
model under FIN 46R should be used to account for existing and new
entities. Chandler USA adopted FIN 46R effective January 1, 2004. The
result of adoption was the deconsolidation of the two capital trusts that
were created during 2003 in connection with the issuance of trust preferred
securities. Chandler USA reports the $20.6 million of junior subordinated
debentures that were issued to the capital trusts on its consolidated
balance sheet. The adoption of FIN 46R had no effect on net earnings.
PAGE F-16
NOTE 6. SHAREHOLDER'S EQUITY
CAPITAL STOCK
In addition to the regulatory oversight of NAICO by the Oklahoma
Department of Insurance, Chandler Insurance Company Ltd. ("Chandler
Insurance"), Chandler USA's parent company, and Chandler USA are also
subject to regulation under the insurance laws of Oklahoma (the "Oklahoma
Insurance Code"). In addition to various reporting requirements imposed on
Chandler Insurance and Chandler USA, the Oklahoma Insurance Code requires
any person who seeks to acquire or exercise control over NAICO (which is
presumed to exist if any person owns 10% or more of Chandler Insurance's or
Chandler USA's outstanding voting stock) to file and obtain approval of
certain applications with the Oklahoma Department of Insurance regarding
their proposed ownership of such shares.
STATUTORY FINANCIAL INFORMATION AND MINIMUM CAPITAL REQUIREMENTS
NAICO is required to file financial statements with state regulatory
authorities prepared on a statutory basis which differs from GAAP. Statutory
net income (loss) and statutory capital and surplus of NAICO are as follows:
2004 2005 2006
-------- -------- --------
(In thousands)
Statutory net income (loss) ....... $(7,482) $ 5,915 $ 3,789
Statutory capital and surplus ..... $41,458 $47,285 $51,663
During 2005, the Oklahoma Insurance Code was amended to allow domestic
insurers to admit office equipment, furniture and other such property
constituting less than 3% of its otherwise admitted assets. This prescribed
accounting practice increased NAICO's statutory capital and surplus by
$510,000 and $404,000 at December 31, 2005 and 2006, respectively. There is
no difference between NAICO's statutory net income under the National
Association of Insurance Commissioners' ("NAIC") ACCOUNTING PRACTICES AND
PROCEDURES manual and practices prescribed by the Oklahoma Insurance Code.
The Oklahoma Insurance Commissioner has the right to permit other
specific practices that deviate from prescribed practices. NAICO does not
have any such permitted practices.
The NAIC has adopted risk-based capital ("RBC") standards for domestic
property and casualty insurance companies. The RBC standards are designed to
assist insurance regulators in analytically determining a level of capital
and surplus that would be sufficient to withstand reasonably foreseeable
adverse events associated with underwriting risk, investment risk, credit
risk and loss reserve risk. NAICO is subject to the RBC standards. Based
on available information, management believes NAICO complied with the RBC
standards at December 31, 2005 and 2006.
At periodic intervals, various insurance regulatory authorities
routinely examine the required statutory financial statements of NAICO as
part of their legally prescribed oversight of the insurance industry.
Based on these examinations, the regulators can direct such financial
statements to be adjusted in accordance with their findings.
DIVIDEND RESTRICTIONS
The amount of cash shareholder dividends that NAICO can pay to Chandler
USA within any one year without the approval of the Oklahoma Department of
Insurance is generally limited to the greater of (i) statutory net income
excluding realized capital gains for the preceding year, or (ii) 10% of
statutory surplus as regards policyholders as of the preceding December 31
with such amount not to exceed NAICO's statutory earned surplus. Based on
this criteria the maximum shareholder dividend NAICO may pay in 2007 without
the approval of the Oklahoma Department of Insurance is approximately $5.2
million. NAICO paid cash shareholder dividends to Chandler USA totaling $3.4
million in 2004.
The future payment of shareholder dividends also depends upon the
earnings, financial position and cash requirements of Chandler USA, as well
as regulatory limitations and such other factors as the board of directors
may deem relevant.
NAICO is subject to regulations which restrict its ability to pay
dividends to policyholders. The maximum amount of available policyholder
dividends is limited to statutory earned surplus (approximately $14.0 million
as of December 31, 2006). NAICO paid approximately $62,000 and $4,000 in
policyholder dividends during 2004 and 2006, respectively. NAICO did not
pay any policyholder dividends during 2005.
PAGE F-17
NOTE 7. INCOME TAXES
Chandler USA and its wholly owned subsidiaries file a consolidated U.S.
Federal income tax return. The income taxes reflected in the accompanying
consolidated statements of operations differ from those expected using U.S.
Federal enacted income tax rates as noted by the following:
2004 2005 2006
---------- ---------- ----------
(In thousands)
Computed income tax provision (benefit) at 34% ................... $ (3,599) $ 2,340 $ 1,721
Increase (decrease) in income taxes resulting from:
Utilization of capital loss carryforward ....................... (248) (104) (253)
Nondeductible meals and entertainment expenses ................. 181 164 163
Other nondeductible expenses ................................... 84 50 34
---------- ---------- ----------
Federal income tax provision (benefit) ........................... $ (3,582) $ 2,450 $ 1,665
========== ========== ==========
U.S. Federal income tax provision (benefit) consists of:
CURRENT DEFERRED TOTAL
---------- ---------- ----------
(In thousands)
2004 ............................................................. $ - $ (3,582) $ (3,582)
2005 ............................................................. 160 2,290 2,450
2006 ............................................................. - 1,665 1,665
Deferred income tax provision (benefit) relating to temporary
differences includes the following components:
2004 2005 2006
---------- ---------- ----------
(In thousands)
Loss reserve discounts ........................................... $ (796) $ 454 $ 66
Unearned premiums ................................................ (372) (256) 62
Deferred policy acquisition costs ................................ (37) 397 (129)
Investment in limited partnerships ............................... - (126) (152)
Alternative minimum tax .......................................... - (160) -
Reserve for uncollectible premiums receivable .................... 5 (36) 18
Depreciation and lease expense ................................... 5 (106) (70)
Discount on fixed maturity investments ........................... 11 26 23
Accrual of prejudgment interest income ........................... - - 1,410
Net operating loss carryforwards ................................. (2,345) 2,076 530
Other ............................................................ (53) 21 (93)
---------- ---------- ----------
$ (3,582) $ 2,290 $ 1,665
========== ========== ==========
PAGE F-18
The tax effect of temporary differences between the consolidated
financial statement carrying amounts and tax bases of assets and liabilities
that give rise to significant portions of the net deferred tax assets, which
are included in other assets, at December 31, relate to the following:
2005 2006
------------ ------------
(In thousands)
Deferred tax assets:
Loss reserve discounts ...................................... $ 2,116 $ 2,049
Unearned premiums ........................................... 2,246 2,183
Compensated absences ........................................ 227 227
Net operating loss carryforwards - federal .................. 1,942 1,572
Net operating loss carryforwards - state .................... 3,254 3,230
Net capital loss carryforward ............................... 1,071 818
Investment in limited partnership ........................... 126 278
Alternative minimum tax ..................................... 160 -
Unrealized loss on investments available for sale ........... 508 569
Other ....................................................... 186 262
Valuation allowance ......................................... (4,325) (4,048)
------------ ------------
Total deferred tax assets ..................................... 7,511 7,140
------------ ------------
Deferred tax liabilities:
Depreciation and lease expense .............................. 1,370 1,300
Accrual of prejudgment interest income ...................... - 1,410
Deferred policy acquisition costs ........................... 416 287
Other ....................................................... 129 150
------------ ------------
Total deferred tax liabilities ................................ 1,915 3,147
------------ ------------
Net deferred tax assets ....................................... $ 5,596 $ 3,993
============ ============
At December 31, 2006, Chandler USA had a net operating loss carryforward
available for U.S. Federal income taxes of $4.6 million which begins to
expire in 2024. Chandler USA has concluded that the deferred tax asset
including the federal net operating loss carryforwards are more likely than
not to be realized. Chandler USA anticipates that its future U.S.
consolidated income will be sufficient to utilize the federal net operating
losses within the required time. Chandler USA will continue to evaluate
income generated in future periods in determining the reasonableness of its
position. If Chandler USA determines that future income is insufficient to
cause the realization of the federal net operating losses within the required
time, a valuation allowance will be established.
In addition, Chandler USA, at December 31, 2006, had net operating loss
carryforwards available for Oklahoma state income taxes totaling
approximately $53.8 million which expire in the years 2007 through 2026. At
December 31, 2006, Chandler USA also had a capital loss carryforward for
U.S. Federal income taxes of $2.4 million which expires in 2007. Chandler
USA's capital loss carryforward increased in 2005 due to Chandler USA
finalizing the sales price of a subsidiary sold in 2002. A valuation
allowance has been provided for the tax effect of the state net operating
loss and the net capital loss carryforwards since realization of such amounts
is not considered more likely than not.
NOTE 8. EMPLOYEE BENEFITS
Chandler USA and its subsidiaries participate in a defined contribution
retirement plan established under Section 401(k) of the Internal Revenue
Code. All full time employees who have completed one year of service and
attained age 21 may elect to participate in the 401(k) plan. Participants
may contribute up to 25% of compensation, subject to certain limitations.
Chandler USA matches 50% of the first $2,000, 40% of the next $3,000, 30%
of the next $3,000 and 25% of the remaining employee contributions up to a
maximum employer contribution of $6,100 per employee per year. In addition,
Chandler USA may make additional annual contributions to the 401(k) plan at
its discretion. Chandler USA's expense for 401(k) plan contributions was
$321,000, $315,000 and $307,000 for 2004, 2005 and 2006, respectively.
NOTE 9. FAIR VALUE DISCLOSURES OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial
instruments is made in accordance with the requirements of SFAS 107,
DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS. The estimated fair
value amounts have been determined by Chandler USA using available market
information and appropriate valuation methodologies. However, considerable
judgment is necessarily required in interpreting market data to develop the
estimates of fair value. Accordingly, the estimates of fair values presented
herein are not necessarily indicative of the amounts that Chandler USA could
realize in a current market exchange. The use of different market
assumptions and/or estimation methodologies may have a material effect on
the estimated fair value amounts.
PAGE F-19
A number of Chandler USA's significant assets (including deferred policy
acquisition costs, property and equipment, reinsurance recoverables, prepaid
reinsurance premiums and state insurance licenses) and liabilities (including
unpaid losses and loss adjustment expenses and unearned premiums) are not
considered financial instruments. Based on the short term nature or other
relevant characteristics, Chandler USA has concluded that the carrying value
of other assets and liabilities considered financial instruments, such as
cash equivalents, premiums receivable, policyholder deposits, accrued taxes
and other payables, and premiums payable, approximates their fair value as
of December 31, 2005 and 2006. The estimated fair values of Chandler USA's
fixed-maturity and equity security investments are disclosed at Note 2. At
December 31, 2006, the fair value of Chandler USA's Debentures was estimated
to be $5.8 million based on the latest reported trade. Chandler USA's
Debentures have not historically traded regularly, and settlement at the
reported fair value may not be possible. The Debentures are redeemable by
Chandler USA on or after July 16, 2009 without penalty or premium, but may be
purchased and cancelled by Chandler USA at a price of less than the sum of
the principal amount and accrued interest at any time. Chandler USA is
obligated for $13.4 million principal amount of junior subordinated
debentures that mature in 2033 with a fixed interest rate of 9.75%, and $7.2
million principal amount of junior subordinated debentures that mature in
2034 with a floating rate of 4.10% over LIBOR. The interest rate at
December 31, 2006 was 9.47%. At December 31, 2006, the fair value of
Chandler USA's junior subordinated debentures was estimated to be $21.7
million.
NOTE 10. LITIGATION
In October 1999, NAICO provided surety bonds for Gulsby Engineering,
Inc. ("Gulsby") in connection with contracts between Gulf Liquids New River
Project, LLC ("Gulf Liquids") and Gulsby for the construction of two gas
processing plants in Louisiana. During 2001, Gulsby became unable to pay
various vendors resulting in payments to vendors by NAICO totaling
$20,182,499. In August 2001, NAICO filed suit in federal court in
Louisiana alleging that Gulf Liquids had breached its obligations under
the bonds by materially altering certain contracts and that, as a result,
NAICO was exonerated on the bonds and should recover the amounts paid to
vendors. In the fall of 2001, Gulsby and Bay Limited, another contractor
with whom Gulsby had entered into a joint venture for the construction of
other gas processing plants for Gulf Liquids, filed lawsuits relating to
those plants in Houston, Texas. Gulf Liquids filed original actions and
counterclaims. NAICO intervened in the Texas lawsuits and, in addition,
sued Williams Energy Marketing and Trading (which later became Williams
Power Company, Inc.) ("Williams") alleging fraud, breach of contract,
tortious interference with contractual relations, conspiracy and alter ego.
These claims were asserted against both Gulf Liquids and Williams. Gulf
Liquids asserted counterclaims alleging breach of contract against NAICO
and requesting contractual and statutory damages ranging from $40 million
to $80 million. The cases were consolidated for trial in the 215th Judicial
District Court in Harris County, Texas.
The trial in the Harris County cases began in late April 2006, and
concluded August 1, 2006. The jury found in favor of NAICO, Gulsby, Bay
Limited and the joint venture between Gulsby and Bay Limited ("Gulsby-Bay
Plant Partners") on all counts and fixed damages against Gulf Liquids and
Williams totaling $402,568,089.53. The damages determined by the jury
included a total of $325 million in punitive damages. Among other findings,
the jury found:
1. Williams tortiously interfered with NAICO's contractual relationship with
Gulsby and Gulf Liquids; and
2. Williams fraudulently induced NAICO to issue the surety bonds; and
3. Williams defrauded NAICO after the bonds were issued; and
4. Williams' actions were malicious; and
5. Gulf Liquids fraudulently induced NAICO to issue the surety bonds; and
6. Gulf Liquids breached its obligations to NAICO under the bonds; and
7. Williams is responsible for the claims against Gulf Liquids because
Gulf Liquids is the alter ego of Williams; and
8. There were material alterations (cardinal changes) to the contracts
NAICO bonded.
The amounts the jury found owing to NAICO include $20,182,499 in actual
damages, against both Gulf Liquids and Williams, $20 million in punitive
damages against Gulf Liquids, and $50 million in punitive damages against
Williams. The verdicts in favor of Gulsby included $20,941,436 in actual
damages against both Gulf Liquids and Williams, $25 million in punitive
damages against Gulf Liquids and $60 million in punitive damages against
Williams.
NAICO is subrogated to any recovery by Gulsby to the extent of NAICO's
losses on the bonds including loss adjustment expenses with interest from
the date the losses and loss expenses were paid.
A significant amount of NAICO's losses on the surety bonds were ceded to
various reinsurers and NAICO will be required to reimburse these reinsurers
in accordance with the agreements between NAICO and the reinsurers.
PAGE F-20
On October 30, 2006, NAICO filed its Motion for Entry of Judgment
requesting that the Trial Court enter judgment on the jury verdicts for a
total of $100,577,559 plus court costs and anticipated attorney fees for
appeals. This request for judgment will be reviewed by the Trial Court and
a judgment entered after the Trial Court has considered objections by
Williams and Gulf Liquids. Of the total requested judgment, $70,000,000 is
punitive damages and $8,328,824 is prejudgment interest through November 1,
2006. Prejudgment interest accrues at the rate of $4,561 per day based upon
an 8.25% interest rate. NAICO has requested attorney fees of $4,566,236
through entry of judgment. The Trial Court denied that request on January
5, 2007. Gulsby has filed a separate motion for judgment that includes a
request for fees. The request for judgment takes into account mandatory
credits for a pre-verdict settlement with parties other than Williams and
Gulf Liquids. NAICO expects the Trial Court to enter judgment based upon
its request during 2007. When entering judgment, the Court may enter
judgment based upon NAICO's request or may enter a different judgment.
After judgment is entered, all parties may file post-judgment motions.
Following the Court's rulings on post-judgment motions, all parties may
appeal all or any of those rulings or judgments.
During the third quarter of 2006, NAICO increased the estimated
recovery on the surety bond claims related to the construction of the two
gas processing plants which resulted in a decrease in losses and loss
adjustment expenses incurred of $4.7 million. Unpaid losses and loss
adjustment expenses decreased $22.7 million, reinsurance recoverable on
unpaid losses and loss adjustment expenses decreased $16.8 million, and
reinsurance recoverable on paid losses and loss adjustment expenses
decreased $1.2 million as of December 31, 2006 as a result of increasing
the estimated recovery. NAICO has also recorded $6.6 million of interest
income for its estimate of prejudgment interest through December 31, 2006,
including a recovery for a pre-verdict settlement with certain other
parties. Prejudgment interest will continue to accrue at 8.25%.
NOTE 11. COMMITMENTS AND CONTINGENCIES
REINSURANCE
In the ordinary course of business, NAICO cedes insurance to other
insurers and reinsurers under various reinsurance treaties that cover
individual risks (facultative reinsurance) or entire classes of business
(treaty reinsurance). Reinsurance provides greater diversification of
business written and also reduces NAICO's exposure arising from high limits
of liability or from hazards of an unusual nature. Amounts recoverable from
reinsurers are estimated in a manner consistent with the claim liability
associated with the reinsured policies. In formulating its reinsurance
programs, NAICO considers numerous factors, including the financial
stability of the reinsurer, ability to provide sufficient collateral (if
required), reinsurance coverage offered and price.
NAICO has structured separate reinsurance programs for property
(including inland marine), workers compensation, casualty (including
automobile liability, general and products liability, umbrella liability
and related professional liability), automobile physical damage, homeowners
and construction surety bonds. Chandler Insurance reinsures NAICO for a
portion of the risk on NAICO's reinsurance programs except for the homeowners
program.
In addition, NAICO purchases catastrophe protection to limit its
retention for single loss occurrences involving multiple policies and/or
policyholders, such as floods, winds and severe storms. NAICO also
purchases facultative reinsurance when it writes a risk with limits of
liability exceeding the maximum limits of its treaties or when it otherwise
considers such action appropriate.
Treaty reinsurance may be ceded under treaties on both a pro rata basis
(where the reinsurer shares proportionately in premiums and losses) and an
excess of loss basis (where only losses above a specific amount are
reinsured). The availability, costs and limits of reinsurance purchased can
vary from year to year based upon prevailing market conditions, reinsurers'
underwriting results and NAICO's desired risk retention levels. A majority
of NAICO's reinsurance programs renew on January 1 or July 1 of each year.
NAICO renewed all applicable January 1, 2007 reinsurance programs. NAICO
discontinued its property reinsurance program effective January 1, 2007
due to the transfer of its commercial property business to another
insurance company. See Note 15 for more information. At the present
time, NAICO expects to renew the reinsurance programs that renew on July
1, 2007.
NAICO periodically reviews certain prospective single year reinsurance
treaties, subject to commutation provisions therein, to determine if it is
advantageous to assume the estimated loss exposure on expired insurance
policies covered by such treaties in exchange for return premiums.
Commutation of such reinsurance treaties will be determined in future
periods based on timely review of all available data. NAICO reviews the
historical results for reinsurance contracts with similar commutation
provisions and accrues for such commutations where a commutation election
is considered probable.
Reinsurance contracts do not relieve an insurer from its obligation
to policyholders. Failure of reinsurers to honor their obligations could
result in losses to Chandler USA; consequently, adjustments to ceded losses
and loss adjustment expenses are made for amounts deemed uncollectible.
During 2004, 2005 and 2006, NAICO incurred charges of $282,000, $108,000
and $97,000, respectively, in adjustments to ceded losses and loss
adjustment expenses for amounts deemed uncollectible.
PAGE F-21
The effect of reinsurance on premiums written and earned was as follows:
2004 2005 2006
----------------------- ----------------------- -----------------------
WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED
----------- ---------- ----------- ---------- ----------- ----------
(In thousands)
Direct ........... $ 121,146 $ 117,383 $ 119,051 $ 115,849 $ 104,037 $ 109,637
Assumed .......... 505 484 1,293 570 9,006 5,223
Ceded ............ (51,187) (53,825) (50,218) (50,359) (48,254) (49,156)
----------- ---------- ----------- ---------- ----------- ----------
Net premiums ..... $ 70,464 $ 64,042 $ 70,126 $ 66,060 $ 64,789 $ 65,704
=========== ========== =========== ========== =========== ==========
Losses and loss adjustment expenses are reported net of the effect of
reinsurance recoveries and recoverables in the consolidated statements of
operations. Ceded losses and loss adjustment expenses were $52.1 million,
$50.3 million and $10.2 million for 2004, 2005 and 2006, respectively.
SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK
NAICO conducts its business through individual independent insurance
agencies and underwriting managers. Certain of these underwriting managers
have provided collateral to NAICO to secure a portion of the premiums
receivable. Substantially all of the principal shareholders of the
independent agencies and underwriting managers have provided personal
guarantees for payment of premiums to NAICO. NAICO also requires certain
policyholders to pay a deposit at the time of inception of coverage to
secure payment of future premiums or other policy related obligations.
Receivables under installment plans do not exceed the corresponding
liability for unearned premiums. Total consolidated premiums receivable at
December 31, 2005 and 2006 were $28.3 million and $31.0 million,
respectively. Receivables for deductibles, in most cases, are secured by
cash deposits and letters of credit. At December 31, 2006, NAICO maintained
custody of such letters of credit securing these and other transactions
totaling approximately $24.9 million, which is a reasonable estimate of
their fair value. These letters of credit are not reflected in the
accompanying consolidated financial statements. During 2004, 2005 and 2006,
one unaffiliated independent insurance agent produced approximately 13%,
12% and 12%, respectively, of NAICO's direct written and assumed premiums.
Approximately $11.8 million, or 18% of NAICO's reinsurance recoverables
and prepaid reinsurance premiums at December 31, 2006 are collateralized by
premiums payable to the reinsurers, securities pledged in trust or letters
of credit for the benefit of NAICO. Chandler USA believes the above value
of such collateral is a reasonable estimate of their fair value. NAICO's
reinsurance contracts include provisions for offsets against premiums owed
to the reinsurers.
PAGE F-22
The following table sets forth certain information related to NAICO's
five largest reinsurers determined on the basis of net reinsurance
recoverables as of December 31, 2006.
CEDED REINSURANCE
NET PREMIUMS FOR A.M. BEST
REINSURANCE THE YEAR ENDED COMPANY
NAME OF REINSURER RECOVERABLE (1) DECEMBER 31, 2006 RATING
- ---------------------------------------------------------- --------------- ------------------- ----------
(Dollars in thousands)
Chandler Insurance ....................................... $ 29,090 $ 27,156 (2)
Employers Reinsurance Corporation ........................ 21,325 3,327 A
Swiss Reinsurance America Corporation .................... 12,725 241 A+
Odyssey America Reinsurance Corporation .................. 4,848 4,092 A
XL Reinsurance America Inc. .............................. 2,052 661 A+
--------------- -------------------
Top five reinsurers ................................. $ 70,040 $ 35,477
=============== ===================
All reinsurers ...................................... $ 63,368 $ 48,254
=============== ===================
Percentage of total represented by top five reinsurers ... 111% 74%
- -------------------------------------------------------------
<FN>
(1) Includes losses and loss adjustment expenses paid and outstanding, unpaid losses and loss adjustment
expenses and prepaid reinsurance premiums recoverable from reinsurers as of December 31, 2006. The
net amount recoverable from all reinsurers is less than the net amount recoverable for the top five
reinsurers due to a significant amount of estimated recoveries that were ceded to reinsurers other
than those listed above. See Note 3 for more information.
(2) Chandler Insurance owns 100% of the common stock of Chandler USA, which in turn owns 100% of the common
stock of NAICO. Chandler Insurance does not have an A.M. Best Company rating. Although Chandler
Insurance is not subject to the minimum capital, audit, reporting and other requirements imposed by
regulation upon United States reinsurance companies, as a foreign reinsurer, it is required to secure
its reinsurance obligations by depositing acceptable securities in trust for NAICO's benefit. At
December 31, 2006, Chandler Insurance had cash and investments, including accrued interest, with a
fair value of $28.3 million deposited in a trust account for the benefit of NAICO.
OTHER
See Note 10 regarding contingencies relating to litigation matters.
Chandler USA has an employment agreement with W. Brent LaGere, Chairman
of the Board and Chief Executive Officer of Chandler USA and its
subsidiaries. Under this agreement, Mr. LaGere's base compensation is
established at not less than $250,000 per year. In the event that Mr.
LaGere is terminated without cause, as defined in the agreement, he is
entitled to receive his base compensation for the remainder of the term of
the agreement, but in no event for more than 60 months. The agreement will
terminate upon Mr. LaGere attaining age 70, unless earlier terminated by
Chandler USA for cause. In addition to his base compensation, Mr. LaGere
is eligible to receive certain benefits and bonuses from Chandler USA and
its subsidiaries.
In addition, certain executives are eligible to receive bonuses based
upon various factors.
NAICO is subject to a variety of assessments related to insurance
activities, including those by state guaranty funds and workers
compensation second-injury funds. The amounts and timing of such
assessments are beyond the control of NAICO. NAICO provides for these
charges on a current basis by applying historical factors to premiums
earned. Actual results may vary from these values and adjustments
therefrom are necessary to maintain an adequate reserve for these
assessments. The reserve for unpaid assessments which is included in
accrued taxes and other payables was approximately $1,129,000 and
$914,000 at December 31, 2005 and 2006, respectively. In certain cases,
NAICO is permitted to recover a portion of its assessments generally as
a reduction to premium taxes paid to certain states. NAICO has recorded
receivables which are included in other assets in the amount that it
expects to recover of approximately $3,031,000 and $2,870,000 at December
31, 2005 and 2006, respectively. NAICO may receive additional guaranty
fund assessments in the future related to insolvent insurance companies.
At this time, NAICO is unable to estimate the amount and timing of such
assessments.
PAGE F-23
At December 31, 2006, Chandler USA's subsidiaries were committed under
noncancellable operating and capital leases for certain equipment and office
space. Rental payments under these leases were $825,000, $780,000 and
$777,000 in 2004, 2005 and 2006, respectively. Future minimum lease payments
are as follows:
(In thousands)
2007 .......................... $ 280
2008 .......................... 127
2009 .......................... 59
2010 .......................... 17
2011 .......................... -
--------------
$ 483
==============
During March 2001, Chandler USA entered into a $3.8 million sale and
leaseback transaction for certain owned equipment for three years. The sale
and leaseback transaction resulted in a deferred gain of $2.0 million which
was amortized into income over the final year of the lease, resulting in
other income of $1.7 million in 2003 and $368,000 in 2004. During March
2004, the lease was extended for 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 9.25% at December 31, 2006. During March 2007,
the lease was extended for an additional three years with monthly rental
installments equal to the sum of (i) $13,834 plus (ii) interest on the
unpaid lease balance at 1% over JP Morgan Chase Bank prime. Chandler USA
has the option to repurchase the equipment at the end of the lease for
approximately $1.9 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 $1.5 million.
Chandler USA has guaranteed the obligations of Trust I and Trust II.
It guarantees payment of distributions and the redemption price of the trust
preferred securities until the securities are redeemed in full. The total
redemption price of the trust preferred securities is $20.0 million.
NOTE 12. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
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 three years, and during
March 2007 the lease was extended for an additional three years. See
Note 11 to Consolidated Financial Statements for additional information.
The bank that participated in the sale and leaseback transaction also
established a letter of credit in the amount of $500,000 on behalf of
Chandler USA for the benefit of Brown & Brown, Inc. as security in
connection with the sale of a subsidiary. Chandler USA paid a fee of
$5,000 during 2004 to the bank for issuing the letter of credit. The
letter of credit expired on December 31, 2005. A director of NAICO and
Chandler USA is an officer and director of the bank that participated in
these transactions, and is also a significant shareholder of the bank's
holding company. This director is also a director of the bank that Chandler
USA and its subsidiaries use as their principal disbursement bank, and is a
significant shareholder of the bank's holding company. The balance
maintained by Chandler USA and each subsidiary is fully insured by the
Federal Deposit Insurance Corporation, and Chandler USA and its subsidiaries
pay customary service charges to the bank for the services provided.
During the second quarter of 2006, CIMI purchased two limited
partnership units in Basin Drilling #2 LP for $2,000, and purchased 8%
cumulative subordinated debentures in the amount of $500,000. The timing
of payment of interest and principal on the debentures is subject to various
restrictions contained in the cumulative subordinated debenture note. The
purpose of the partnership is to own and operate an oil and gas drilling
rig. CIMI financed the purchase with a $500,000 variable rate bank loan.
Principal and interest payments are due on the bank loan in five quarterly
installments beginning September 1, 2006. Interest is payable at 1% over
New York Prime, which was 9.25% at December 31, 2006. The partnership is
managed by Basin Management, LLC ("BMLLC") who is the General Partner. A
director of NAICO and Chandler USA is the Manager for BMLLC, and is also a
director of the bank and a significant shareholder of the bank holding
company that provided the bank loan described above.
Chandler USA leases and has made certain improvements to a rural
property in which certain directors and officers of Chandler USA own
interests. Under the lease, no cash rental is paid. Chandler USA drilled
a water well on the property and maintains certain structures it regularly
uses. This property provides recreational activities for the entertainment
of customers and business associates of Chandler USA's subsidiaries.
Chandler USA incurred approximately $353,000, $313,000 and $308,000 in
expenses associated with this property during 2004, 2005 and 2006,
respectively, including $14,000, $10,000 and $11,000 for reimbursement of
certain expenses, such as utility and similar expenses, for the years 2004,
2005 and 2006, respectively.
PAGE F-24
Chandler USA and Chandler Insurance are parties to 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. At December 31,
2005 and 2006, Chandler USA had a receivable of $9.4 million and $9.6
million, respectively, under the Credit Agreement, and Chandler USA earned
$439,000, $614,000 and $733,000 in interest income under the Credit Agreement
during 2004, 2005 and 2006, respectively.
NOTE 13. SEGMENT INFORMATION
Chandler USA has one reportable operating segment for property and
casualty insurance. The insurance products reported in the property and
casualty segment are underwritten by NAICO and are marketed through
independent insurance agencies. NAICO underwrites various lines of property
and casualty insurance, including surety bonds and workers compensation
insurance. NAICO's main areas of concentration include the construction,
manufacturing, oil and gas, trucking, wholesale, service and retail
industries along with political subdivisions. The property and casualty
segment operates primarily in Oklahoma and Texas, and other surrounding
states. Oklahoma accounted for approximately 51%, 47% and 51% of gross
written premiums in 2004, 2005 and 2006, respectively, while Texas accounted
for approximately 37%, 36% and 26% of gross written premiums during the same
years. Management evaluates the property and casualty segment's performance
on the basis of growth in gross written premiums and income before income
taxes.
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. 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.
YEAR ENDED DECEMBER 31,
----------------------------------
INSURANCE PROGRAM 2004 2005 2006
- ---------------------------------------------------------- ---------- ---------- ----------
(In thousands)
NET PREMIUMS EARNED
Standard lines ........................................... $ 54,278 $ 54,979 $ 54,357
Political subdivisions ................................... 7,269 6,690 5,253
Homeowners ............................................... - 3,321 5,353
Surety bonds ............................................. 1,993 669 193
Other (1) ................................................ 502 401 548
---------- ---------- ----------
$ 64,042 $ 66,060 $ 65,704
========== ========== ==========
LOSSES AND LOSS ADJUSTMENT EXPENSES
Standard lines ........................................... $ 42,901 $ 33,512 $ 40,212
Political subdivisions ................................... 7,122 4,091 2,693
Homeowners ............................................... - 1,306 2,515
Surety bonds ............................................. 2,677 (1,704) (152)
Other (1) ................................................ 1,081 119 205
---------- ---------- ----------
$ 53,781 $ 37,324 $ 45,473
========== ========== ==========
- --------------------------
<FN>
(1) This category is comprised primarily of the run-off of discontinued programs and NAICO's
participation in various mandatory workers compensation pools.
PAGE F-25
NOTE 14. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
A summary of the unaudited quarterly operating results during 2005 and
2006 follows:
First Second Third Fourth Total
quarter quarter quarter quarter year
--------- --------- --------- --------- --------
2005
- -----------------------------------------------------
Net premiums earned ................................ $ 16,224 $ 16,294 $ 16,726 $ 16,816 $ 66,060
Investment income, net ............................. 821 845 880 922 3,468
Realized investment gains, net ..................... - 3 - 380 383
Income before income taxes ......................... 3,370 2,485 460 568 6,883
Net income ......................................... 2,155 1,595 251 432 4,433
2006
- -----------------------------------------------------
Net premiums earned ................................ $ 16,865 $ 16,988 $ 16,029 $ 15,822 $ 65,704
Investment income, net ............................. 895 970 7,366 1,362 10,593
Realized investment gains, net ..................... 56 133 352 204 745
Income (loss) before income taxes .................. 931 (604) 2,737 1,997 5,061
Net income (loss) .................................. 584 (393) 1,875 1,330 3,396
Net investment income included $6.3 million and $324,000 in the third
and fourth quarters of 2006, respectively, for the accrual of prejudgment
interest on a favorable jury verdict in civil litigation regarding certain
surety bond claims. See Note 10.
NOTE 15. SUBSEQUENT EVENT
Effective January 1, 2007, the commercial property and inland marine
lines of insurance that were previously written by NAICO will be written
by Praetorian Insurance Company ("Praetorian") through an arrangement
between Praetorian and CIMI. NAICO also transferred its existing
commercial property and inland marine business to Praetorian under this
new arrangement effective January 1, 2007. Under this arrangement, CIMI
receives commission income for the business it produces for Praetorian.
CIMI is responsible for the payment of commissions to the producing
agents, and is also responsible for providing underwriting and loss
control services for this business. NAICO handles all claims for this
business under a separate claims handling agreement with Praetorian.
* * * * * * *
PAGE F-26
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholder of
Chandler (U.S.A.), Inc.:
We have audited the consolidated balance sheets of Chandler (U.S.A.), Inc.
and subsidiaries ("Chandler USA") as of December 31, 2005 and 2006, and
the related consolidated statements of operations, comprehensive income,
cash flows and shareholder's equity for each of the three years in the
period ended December 31, 2006. Our audits also included the financial
statement schedules of Chandler USA listed in Item 15(a). These financial
statements and financial statement schedules are the responsibility of
Chandler USA's management. Our responsibility is to express an opinion on
these financial statements and financial statement schedules based on our
audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement.
Chandler USA is not required to have, nor were we engaged to perform, an
audit of its internal control over financial reporting. Our audit
included consideration of internal control over financial reporting as a
basis for designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the
effectiveness of Chandler USA's internal control over financial reporting.
Accordingly, we express no such opinion. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Chandler
USA as of December 31, 2005 and 2006, and the results of its operations and its
cash flows for each of the three years in the period ended December 31, 2006
in conformity with U.S. generally accepted accounting principles. Also, in
our opinion, such financial statement schedules, when considered in relation
to the basic consolidated financial statements taken as a whole, present
fairly, in all material respects, the information set forth therein.
/s/ Tullius Taylor Sartain & Sartain LLP
TULLIUS TAYLOR SARTAIN & SARTAIN LLP
Tulsa, Oklahoma
March 27, 2007
PAGE F-27
SCHEDULE I
CHANDLER (U.S.A.), INC. AND SUBSIDIARIES
SUMMARY OF INVESTMENTS - OTHER
THAN INVESTMENTS IN RELATED PARTIES
AS OF DECEMBER 31, 2006
(In thousands)
AMOUNT AT WHICH
SHOWN IN THE
TYPE OF INVESTMENT COST FAIR VALUE BALANCE SHEET
- ----------------------------------------------- ------------ ---------- ---------------
FIXED MATURITIES AVAILABLE FOR SALE:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies ....... $ 37,393 $ 36,447 $ 36,447
Corporate obligations ......................... 23,004 22,179 22,179
Public utilities .............................. 6,376 6,213 6,213
Mortgage-backed securities .................... 1,614 1,540 1,540
------------ ---------- ---------------
68,387 66,379 66,379
EQUITY SECURITIES AVAILABLE FOR SALE:
Corporate stock ............................... 1,587 1,921 1,921
------------ ---------- ---------------
Total investments .......................... $ 69,974 $ 68,300 $ 68,300
============ ========== ===============
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-28
SCHEDULE II
CHANDLER (U.S.A.), INC. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CHANDLER (U.S.A.), INC.
(PARENT COMPANY ONLY)
BALANCE SHEETS
(In thousands except share amounts)
DECEMBER 31,
---------------------
2005 2006
---------- ----------
ASSETS
Cash .............................................................. $ 26 $ -
Amounts due from subsidiaries ..................................... 148 -
Property and equipment, net ....................................... 898 829
Amounts due from related parties .................................. 9,360 9,584
Other assets ...................................................... 4,544 3,678
Investment in subsidiaries, net ................................... 54,363 59,669
---------- ----------
Total assets ...................................................... $ 69,339 $ 73,760
========== ==========
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Accrued taxes and other payables ................................ $ 2,054 $ 1,892
Amounts due to subsidiaries ..................................... - 1,305
Debentures ...................................................... 6,979 6,979
Junior subordinated debentures issued to affiliated trusts ...... 20,620 20,620
---------- ----------
Total liabilities ................................................. 29,653 30,796
---------- ----------
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 ............................................. (19,913) (16,517)
Accumulated other comprehensive income (loss):
Unrealized loss on investments held by subsidiary and available
for sale, net of deferred income taxes ........................ (987) (1,105)
---------- ----------
Total shareholder's equity ....................................... 39,686 42,964
---------- ----------
Total liabilities and shareholder's equity ........................ $ 69,339 $ 73,760
========== =========
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-29
SCHEDULE II
CHANDLER (U.S.A.), INC. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CHANDLER (U.S.A.), INC.
(PARENT COMPANY ONLY)
STATEMENTS OF OPERATIONS
(In thousands)
YEAR ENDED DECEMBER 31,
----------------------------------
2004 2005 2006
---------- ---------- ----------
Revenues
Investment income, net ................................. $ 2 $ 3 $ 4
Interest income, net from related parties .............. 491 670 792
Other income ........................................... 1,370 908 1,334
---------- ---------- ----------
Total revenues ....................................... 1,863 1,581 2,130
---------- ---------- ----------
Operating costs and expenses
General and administrative expenses .................... 2,505 2,749 3,116
Interest expense ....................................... 2,385 2,519 2,649
---------- ---------- ----------
Total operating costs and expenses ................... 4,890 5,268 5,765
---------- ---------- ----------
Loss before income tax benefit ........................... (3,027) (3,687) (3,635)
Federal income tax benefit ............................... 1,137 1,198 1,606
---------- ---------- ----------
Net loss before equity in net
income (loss) of subsidiaries .......................... (1,890) (2,489) (2,029)
Equity in net income (loss) of subsidiaries .............. (5,114) 6,922 5,425
---------- ---------- ----------
Net income (loss) ........................................ $ (7,004) $ 4,433 $ 3,396
========== ========== ==========
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-30
SCHEDULE II
CHANDLER (U.S.A.), INC. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CHANDLER (U.S.A.), INC.
(PARENT COMPANY ONLY)
STATEMENTS OF CASH FLOWS
(In thousands)
YEAR ENDED DECEMBER 31,
----------------------------------
2004 2005 2006
---------- ---------- ----------
Operating activities
Net income (loss) ................................................ $ (7,004) $ 4,433 $ 3,396
Add (deduct):
Adjustments to reconcile net income (loss) to cash
provided by (applied to) operating activities:
Net (income) loss of subsidiaries not distributed to parent .... 5,114 (6,922) (5,425)
Net (gain) loss on sale of property and equipment .............. (371) (7) 8
Gain on retirement of debentures ............................... (36) - -
Amortization and depreciation .................................. 205 210 218
Net change in non-cash balances relating to
operating activities:
Premiums receivable .......................................... 2 7 -
Amounts due from subsidiaries ................................ 161 1,128 148
Other assets ................................................. (922) (121) 809
Accrued taxes and other payables ............................. 581 (234) (162)
Amounts due to subsidiaries .................................. - - 1,306
---------- ---------- ----------
Cash provided by (applied to) operating activities ............. (2,270) (1,506) 298
---------- ---------- ----------
Investing activities
Cost of property and equipment purchased ......................... (154) (130) (145)
Proceeds from sale of property and equipment ..................... 86 67 45
---------- ---------- ----------
Cash applied to investing activities ........................... (68) (63) (100)
---------- ---------- ----------
Financing activities
Shareholder dividend from subsidiaries ........................... 3,400 - -
Payment on retirement of debentures .............................. (226) - -
Debt issue costs ................................................. (18) - -
Payments and loans from related parties .......................... 4,602 2,513 1,747
Payments and loans to related parties ............................ (5,851) (982) (1,971)
---------- ---------- ----------
Cash provided by (applied to) financing activities ............. 1,907 1,531 (224)
---------- ---------- ----------
Decrease in cash ................................................... (431) (38) (26)
Cash at beginning of year .......................................... 495 64 26
---------- ---------- ----------
Cash at end of year ................................................ $ 64 $ 26 $ -
========== ========== ==========
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-31
SCHEDULE III
CHANDLER (U.S.A.), INC. AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
(IN THOUSANDS)
FUTURE
POLICY AMORTI-
BENEFITS, OTHER CLAIMS, ZATION OF NET
DEFERRED LOSSES, POLICY LOSSES DEFERRED PREMIUMS
POLICY CLAIMS CLAIMS AND NET AND POLICY OTHER WRITTEN
ACQUISITION AND LOSS UNEARNED BENEFITS PREMIUM INTEREST SETTLEMENT ACQUISITION OPERATING AND
COSTS EXPENSES PREMIUMS PAYABLE REVENUE INCOME EXPENSES COSTS EXPENSES ASSUMED
----------- --------- -------- ---------- --------- --------- ---------- ----------- --------- --------
DECEMBER 31, 2004
Property and casualty ... $ 57 $ 108,233 $ 51,109 $ 4,912 $ 64,042 $ 3,677 $ 53,781 $ 11,039 $ 14,777 $ 70,464
=========== ========= ======== ========== ========= ========= ========== =========== ========= ========
DECEMBER 31, 2005
Property and casualty ... $ 1,225 $ 109,541 $ 55,034 $ 5,684 $ 66,060 $ 3,468 $ 37,324 $ 10,671 $ 15,284 $ 70,126
=========== ========= ======== ========== ========= ========= ========== =========== ========= ========
DECEMBER 31, 2006
Property and casualty ... $ 845 $ 83,253 $ 53,217 $ 7,663 $ 65,704 $ 10,593 $ 45,473 $ 11,666 $ 15,159 $ 64,789
=========== ========= ======== ========== ========= ========= ========== =========== ========= ========
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-32
SCHEDULE IV
CHANDLER (U.S.A.), INC. AND SUBSIDIARIES
REINSURANCE
(Dollars in thousands)
ASSUMED PERCENTAGE
CEDED TO FROM OF AMOUNT
GROSS OTHER OTHER NET ASSUMED
AMOUNT COMPANIES COMPANIES AMOUNT TO NET
------------ ------------ ------------ ------------ ------------
Year ended December 31, 2004
Property and casualty ........ $ 121,146 $ (51,187) $ 505 $ 70,464 0.72%
============ ============ ============ ============ ============
Year ended December 31, 2005
Property and casualty ........ $ 119,051 $ (50,218) $ 1,293 $ 70,126 1.84%
============ ============ ============ ============ ============
Year ended December 31, 2006
Property and casualty ........ $ 104,037 $ (48,254) $ 9,006 $ 64,789 13.90%
============ ============ ============ ============ ============
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-33
SCHEDULE V
CHANDLER (U.S.A.), INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
BALANCE AT PROVISION BALANCE
BEGINNING FOR AT END
OF PERIOD NON-COLLECTION WRITE-OFFS OF PERIOD
---------------- ---------------- ---------------- ---------------
Allowance for non-collection of
premiums receivable:
2004 ........................... $ 133 $ 42 $ (56) $ 119
================ ================ ================ ===============
2005 ........................... $ 119 $ 176 $ (72) $ 223
================ ================ ================ ===============
2006 ........................... $ 223 $ 73 $ (126) $ 170
================ ================ ================ ===============
Allowance for non-collection of reinsurance
recoverables on paid and unpaid losses:
2004 ........................... $ 3,314 $ 282 $ (324) $ 3,272
================ ================ ================ ===============
2005 ........................... $ 3,272 $ 108 $ (3,206) $ 174
================ ================ ================ ===============
2006 ........................... $ 174 $ 97 $ (141) $ 130
================ ================ ================ ===============
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-34
SCHEDULE VI
CHANDLER (U.S.A.), INC. AND SUBSIDIARIES
SUPPLEMENTAL INFORMATION
(FOR PROPERTY-CASUALTY INSURANCE UNDERWRITERS)
(IN THOUSANDS)
DISCOUNT PAID LOSSES AND
DEDUCTED LOSS ADJUSTMENT
FROM RESERVES EXPENSES
--------------- ----------------
Year ended December 31, 2004
Property-casualty ................... $ - $ 38,429
=============== =================
Year ended December 31, 2005
Property-casualty ................... $ - $ 41,470
=============== =================
Year ended December 31, 2006
Property-casualty ................... $ - $ 43,941
=============== =================
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-35
INDEX TO EXHIBITS
-----------------
Exhibit No.
- -----------
21.1 Subsidiaries of the registrant.
31.1 Rule 13a-14(a)/15d-14(a) Certifications.
32.1 Section 1350 Certifications.