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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------------------
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, 2007
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 X NO
-- --
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, a non-accelerated filer, or a smaller reporting
company. See the definitions of "large accelerated filer," "accelerated
filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer Accelerated filer
-- --
Non-accelerated filer X (Do not check if a smaller reporting company)
--
Smaller reporting company
--
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, 2007, 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 29, 2008 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 197 at December 31, 2007, 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+ (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 are being 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 is no longer 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,
2007, NAICO insured 110 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 are being 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 2005, 2006 and 2007. 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."
<CAPTION
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
-------------------------- --------------------------
INSURANCE PROGRAMS 2005 2006 2007 2005 2006 2007
- ---------------------------------------- -------- -------- -------- -------- -------- --------
(In thousands)
Standard lines ......................... $ 92,224 $ 91,153 $100,844 $ 54,979 $ 54,357 $ 62,342
Political subdivisions ................. 18,630 14,337 5,084 6,690 5,253 3,436
Homeowners ............................. 4,229 8,542 501 3,321 5,353 9
Surety bonds ........................... 930 278 266 669 193 186
Other (1) .............................. 406 550 214 401 548 212
-------- -------- -------- -------- -------- --------
TOTAL .................................. $116,419 $114,860 $106,909 $ 66,060 $ 65,704 $ 66,185
======== ======== ======== ======== ======== ========
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<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,
--------------------------------------------
2003 2004 2005 2006 2007
-------- -------- -------- -------- --------
Automobile liability ........ 27% 28% 29% 32% 40%
Workers compensation ........ 29% 27% 25% 23% 27%
Other liability ............. 23% 28% 27% 25% 23%
Automobile physical damage .. 10% 9% 9% 8% 9%
Property .................... 5% 4% 8% 11% 1%
Inland marine ............... 1% 1% 1% 1% -%
Surety ...................... 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's net premiums earned for property and inland marine
business in 2007 were 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.
The majority of NAICO's reinsurance programs renew on July 1 of each year.
At the present time, NAICO expects to renew the reinsurance programs that
expire on July 1, 2008.
NAICO has structured separate reinsurance programs for workers
compensation, casualty (including automobile liability, general and
products liability, umbrella liability and related professional liability),
automobile physical damage 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.
Effective July 1, 2004, NAICO's net retention under the workers
compensation reinsurance program was 100% of the first $1,000,000 of loss
per occurrence. NAICO's excess of loss reinsurance covers workers
compensation losses up to $30,000,000 effective July 1, 2002.
Effective July 1, 2004, NAICO's net retention under the casualty
reinsurance program was 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, although most policies are issued
with policy limits of $1,000,000 of loss per occurrence for casualty
coverages. 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, 2004, NAICO retains 70% of the losses in the
construction surety bond portion of the surety bond program.
Under the 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 2005, 2006 and 2007 automobile physical damage reinsurance
programs NAICO retained 70% of each loss per occurrence. NAICO has
purchased catastrophe protection for automobile physical damage 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 automobile physical damage to $1,400,000 effective January 1,
2004 for each loss occurrence.
In December 2007, the Terrorism Risk Insurance Program Reauthorization
Act of 2007 (the "Act") extended the Terrorism Risk Insurance Act of 2002
(the "Act") through December 31, 2014. The Act, as modified, establishes a
program for commercial property and casualty losses resulting from foreign
and domestic acts of terrorism. The Act requires commercial insurers to
offer terrorism coverage on certain 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 of 20% of an insurer's
direct earned premium. The Federal Government will pay 85% of covered
terrorism losses that exceed company deductibles.
PAGE 5
For 2007, NAICO purchased excess of loss reinsurance covering acts of
terrorism that provided 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. Effective July 1, 2007, terrorism
coverage was included in the casualty reinsurance program and effective
January 1, 2008, terrorism coverage was included in the workers compensation
reinsurance program.
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, 2007.
CEDED REINSURANCE
NET PREMIUMS FOR A.M. BEST
REINSURANCE THE YEAR ENDED COMPANY
NAME OF REINSURER RECOVERABLE (1) DECEMBER 31, 2007 RATING
- ---------------------------------------------------------- --------------- ------------------ -----------
(Dollars in thousands)
Chandler Insurance ....................................... $ 31,616 $ 27,959 (2)
Employers Reinsurance Corporation ........................ 17,158 (1,354) A+
Swiss Reinsurance America Corporation .................... 17,078 431 A+
Markel Insurance Company ................................. 2,718 1,785 A
Transatlantic Reinsurance Company ........................ 2,380 1,863 A+
--------------- ------------------
Top five reinsurers ................................. $ 70,950 $ 30,684
=============== ==================
All reinsurers ...................................... $ 71,857 $ 35,649
=============== ==================
Percentage of total represented by top five reinsurers ... 99% 86%
- -------------------------------------------------------------
<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, 2007.
(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, 2007, Chandler Insurance had
cash and investments, including accrued interest, with a fair value of $31.6 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 $108,000, $97,000 and $356,000 during 2005, 2006
and 2007, 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,
------------------------------------------------
2003 2004 2005 2006 2007
-------- -------- -------- -------- --------
(Dollars in thousands)
Automobile liability:
Net premiums earned ......................... $ 15,624 $ 17,742 $ 19,126 $ 21,122 $ 26,469
Loss ratio .................................. 49% 61% 82% 99% 74%
Workers compensation:
Net premiums earned ......................... $ 16,378 $ 17,371 $ 16,475 $ 15,361 $ 17,861
Loss ratio .................................. 72% 85% 53% 63% 62%
Other liability:
Net premiums earned ......................... $ 12,870 $ 18,044 $ 18,052 $ 16,628 $ 15,137
Loss ratio .................................. 94% 121% 48% 57% 32%
Automobile physical damage:
Net premiums earned ......................... $ 5,508 $ 5,933 $ 5,807 $ 5,008 $ 6,096
Loss ratio .................................. 36% 43% 56% 63% 55%
Property:
Net premiums earned ......................... $ 3,072 $ 2,611 $ 5,594 $ 7,082 $ 279
Loss ratio .................................. 74% 47% 41% 41% 64%
Surety:
Net premiums earned ......................... $ 2,723 $ 1,993 $ 669 $ 194 $ 186
Loss ratio .................................. 34% 134% (255)% (459)% 1,119%
Inland marine:
Net premiums earned ......................... $ 408 $ 348 $ 337 $ 309 $ 157
Loss ratio .................................. 54% 29% 162% 30% 19%
Total:
Net premiums earned ......................... $ 56,583 $ 64,042 $ 66,060 $ 65,704 $ 66,185
Loss ratio .................................. 66% 84% 57% 69% 63%
Underwriting expense ratio (1) .............. 47% 34% 35% 37% 39%
-------- -------- -------- -------- --------
Combined ratio (1) ........................... 113% 118% 92% 106% 102%
======== ======== ======== ======== ========
- -------------------------------------------------
<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 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 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 $13.2 million and $11.1 million at December 31, 2006 and 2007,
respectively. Included in these recoverable amounts were net recoverables
of $10.8 million and $10.1 million in 2006 and 2007, respectively, 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. 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,
------------------------------------------------------
2003 2004 2005 2006 2007
---------- ---------- ---------- ---------- ----------
(In thousands)
Net balance at beginning of year ................. $ 33,191 $ 29,343 $ 44,695 $ 40,549 $ 42,081
---------- ---------- ---------- ---------- ----------
Net losses and loss adjustment expenses incurred
related to:
Current year ................................. 26,108 27,436 30,985 41,644 40,194
Prior years .................................. 11,092 26,345 6,339 3,829 1,199
---------- ---------- ---------- ---------- ----------
Total ...................................... 37,200 53,781 37,324 45,473 41,393
---------- ---------- ---------- ---------- ----------
Net paid losses and loss adjustment expenses
related to:
Current year ................................. (10,626) (10,222) (11,171) (12,403) (12,494)
Prior years .................................. (30,422) (28,207) (30,299) (31,538) (25,114)
---------- ---------- ---------- ---------- ----------
Total ...................................... (41,048) (38,429) (41,470) (43,941) (37,608)
---------- ---------- ---------- ---------- ----------
Net balance at end of year ....................... $ 29,343 $ 44,695 $ 40,549 $ 42,081 $ 45,866
========== ========== ========== ========== ==========
NAICO has experienced a significant amount of incurred losses related to
prior accident years during the 2003-2006 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.
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.
During 2007, NAICO experienced adverse loss development totaling $1.2
million primarily in the surety bond program. During 2007, a portion of the
estimated recoveries that were recorded in the surety bond program during
2006 were reduced based on a final judgment entered by the court regarding
certain surety bond claims. The reduction of the estimated recoveries
accounted for $1.8 million of the loss development during 2007. The adverse
loss development included approximately $356,000 for provisions for
potentially uncollectible reinsurance.
The following table represents the development of net balance sheet
reserves for 1998 through 2007. 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 2001
for claims that occurred in 1998 will be included in the cumulative
deficiency amount for years 1998, 1999, 2000 and 2001. 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,
------------------------------------------------------------------------------------------------------
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
--------- --------- ---------- ---------- ---------- --------- --------- --------- --------- ---------
(In thousands)
Net reserve for unpaid losses and
loss adjustment expenses ... $ 39,921 $ 51,378 $ 46,707 $ 32,812 $ 33,191 $ 29,343 $ 44,695 $ 40,549 $ 42,081 $ 45,866
Net paid (cumulative) as of
One year later ............ 23,896 36,009 43,799 37,050 30,422 28,207 30,299 31,537 25,111
Two years later ........... 34,966 58,979 66,141 60,560 51,375 50,158 50,183 46,348
Three years later ......... 45,390 72,052 81,635 77,413 68,643 63,900 58,263
Four years later .......... 51,364 80,860 91,403 89,349 79,591 69,099
Five years later .......... 55,445 86,257 97,700 98,060 83,845
Six years later ........... 58,062 88,859 99,506 101,213
Seven years later ......... 59,135 89,346 101,257
Eight years later ......... 58,706 90,708
Nine years later .......... 59,514
Net liability re-estimated as of
One year later ............ 43,441 56,357 59,376 48,596 44,283 55,688 51,034 44,378 43,280
Two years later ........... 45,373 67,469 74,325 67,903 70,058 61,369 50,989 50,909
Three years later ......... 50,146 77,842 86,377 89,608 73,962 61,216 57,175
Four years later .......... 55,303 83,860 100,408 91,520 74,805 66,153
Five years later .......... 58,060 91,704 102,370 91,700 79,781
Six years later ........... 62,995 92,084 104,227 96,161
Seven years later ......... 62,712 93,873 106,396
Eight years later ......... 63,775 95,812
Nine years later .......... 64,778
Net cumulative (deficiency)
redundancy ................ $(24,857) $(44,434) $ (59,689) $ (63,349) $ (46,590) $(36,810) $(12,480) $(10,360) $ (1,199) $ -
Supplemental gross data:
Gross liability ........... $ 80,701 $ 98,460 $ 100,173 $ 84,756 $ 92,606 $ 87,768 $108,233 $109,541 $ 83,253 $100,590
Reinsurance recoverable ... 40,780 47,082 53,466 51,944 59,415 58,425 63,538 68,992 41,172 54,724
--------- --------- ---------- ---------- ---------- --------- --------- --------- --------- ---------
Net liability-end of year.. $ 39,921 $ 51,378 $ 46,707 $ 32,812 $ 33,191 $ 29,343 $ 44,695 $ 40,549 $ 42,081 $ 45,866
========= ========= ========== ========== ========== ========= ========= ========= ========= =========
Gross re-estimated
liability - latest ...... $137,563 $192,297 $ 266,593 $ 300,102 $ 248,595 $182,331 $155,203 $133,425 $101,970
Re-estimated recoverable -
latest .................. 72,785 96,485 160,197 203,941 168,814 116,178 98,028 82,516 58,690
--------- --------- ---------- ---------- ---------- --------- --------- --------- ---------
Net re-estimated
liability - latest ...... $ 64,778 $ 95,812 $ 106,396 $ 96,161 $ 79,781 $ 66,153 $ 57,175 $ 50,909 $ 43,280
========= ========= ========== ========== ========== ========= ========= ========= =========
Gross cumulative (deficiency)
redundancy ................ $(56,862) $(93,837) $(166,420) $(215,346) $(155,989) $(94,563) $(46,970) $(23,884) $(18,717)
========= ========= ========== ========== ========== ========= ========= ========= =========
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, 2007, all of the investments of NAICO were in
fixed-maturity investments (rated A2 or A+ or better by Moody's Investors
Service, Inc. or Standard & Poor's, respectively), certificates of deposit
insured by the Federal Deposit Insurance Corporation ("FDIC"),
interest-bearing money market accounts, collateralized repurchase
agreements and common stock received in connection with an unaffiliated
entity's conversion to a for-profit corporation. 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, 2007, 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 9.34% at December 31, 2007. 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 9.34% at December
31, 2007. 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, 2007, Chandler USA and its subsidiaries had
approximately 201 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 through 2007 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 and 2007. 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, 2007, NAICO had statutory earned surplus of $12.5
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 $5.0 million. NAICO paid
shareholder dividends to Chandler USA totaling $1.6 million in 2007.
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 5.7:1 and 5.9:1 at December 31, 2006 and 2007, 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 two 2007 ratios that were outside of the "usual values" as
explained below.
NAICO's "investment yield" as calculated using the IRIS formula was
0.0% during 2007 compared to a usual value of greater than 3.0% and less
than 6.5%. During 2007, NAICO reversed $4.1 million of accrued prejudgment
interest income based on a final judgment entered by the court related to a
favorable jury verdict in civil litigation regarding certain surety bond
claims. Excluding the reversal of this prejudgment interest, NAICO's
investment yield as calculated using the IRIS formula was 3.5%. 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.
NAICO's "two-year reserve development to policyholders' surplus" for
2007 was 21% compared to a usual value of less than 20%. The primary
reason was adverse loss development experienced during 2006 related to
the 2005 accident year. This adverse loss development related primarily
to the automobile liability line of business in NAICO's standard lines
program.
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 2007 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.
PAGE 16
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.
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 through 2007 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 and 2007. 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.
PAGE 17
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.
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+" (Good), with a
stable outlook. NAICO's rating was 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, 2006 and 2007, 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 2007, approximately 71% 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.
PAGE 18
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.
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.
PAGE 19
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.
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, 2007.
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, 2007 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).
PAGE 20
ITEM 6. SELECTED FINANCIAL DATA (CONTINUED).
YEAR ENDED DECEMBER 31,
-------------------------------------------------
2003 2004 2005 2006 2007
--------- --------- --------- --------- ---------
(Dollars in thousands)
OPERATING DATA
Revenues
Direct premiums written and assumed .................... $118,444 $121,651 $120,344 $113,043 $100,081
========= ========= ========= ========= =========
Net premiums earned .................................... $ 56,583 $ 64,042 $ 66,060 $ 65,704 $ 66,185
Investment income, net (1) ............................. 2,148 3,186 2,798 9,801 (572)
Interest income, net from related parties .............. 412 491 670 792 941
Realized investment gains, net ......................... 2,351 652 383 745 214
Other income (2) ....................................... 5,077 640 251 317 1,916
--------- --------- --------- --------- ---------
Total revenues ........................................... 66,571 69,011 70,162 77,359 68,684
--------- --------- --------- --------- ---------
Operating expenses
Losses and loss adjustment expenses .................... 37,200 53,781 37,324 45,473 41,393
Policy acquisition costs ............................... 11,278 11,039 10,671 11,666 12,547
General and administrative expenses .................... 13,486 12,380 12,749 12,469 12,790
Interest expense ....................................... 2,441 2,397 2,535 2,690 2,703
--------- --------- --------- --------- ---------
Total operating expenses ................................. 64,405 79,597 63,279 72,298 69,433
--------- --------- --------- --------- ---------
Income (loss) before income taxes ........................ 2,166 (10,586) 6,883 5,061 (749)
Federal income tax benefit (provision) ................... (192) 3,582 (2,450) (1,665) 87
--------- --------- --------- --------- ---------
Net income (loss) ........................................ $ 1,974 $ (7,004) $ 4,433 $ 3,396 $ (662)
========= ========= ========= ========= =========
Combined loss and underwriting expense ratio (3) ......... 113% 118% 92% 106% 102%
BALANCE SHEET DATA
Cash and investments ..................................... $ 69,198 $ 86,913 $ 86,316 $ 89,703 $ 97,199
Amounts due from related parties ......................... 9,642 10,891 9,360 9,584 11,506
Total assets ............................................. 218,213 237,297 245,059 222,772 234,367
Unpaid losses and loss adjustment expenses ............... 87,768 108,233 109,541 83,253 100,590
Debentures ............................................... 7,254 6,979 6,979 6,979 6,979
Junior subordinated debentures issued to affiliated
trusts ................................................. 20,620 20,620 20,620 20,620 20,620
Total liabilities ........................................ 174,374 201,105 205,373 179,808 190,763
Shareholder's equity ..................................... 43,839 36,192 39,686 42,964 43,604
- ------------------------------------------------------------
<FN>
(1) 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. In January 2008, the court
entered a final judgment on this matter which resulted in the accrual of prejudgment interest being reduced
by $4.1 million during 2007. For additional information, see "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS."
(2) 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. Other income increased in 2007 due to a new arrangement
between CIMI and Praetorian covering property and inland marine business previously written by NAICO. See
"Insurance Programs" for more information.
(3) 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, 2007, Chandler USA had a net loss of
$662,000 compared to net income of $3.4 million for 2006 and a net income of
$4.4 million for 2005. The net loss in 2007 was primarily due to the
reversal of a portion of the prejudgment interest income that was accrued
during 2006 on a favorable jury verdict. This is discussed in more detail
under "Litigation" and in Note 10 to Consolidated Financial Statements.
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, 2007,
NAICO's case reserves and IBNR for each line of business are shown in the
following table.
Gross reserves at December 31, 2007 Net reserves at December 31, 2007
----------------------------------- ---------------------------------
Case Total Case Total
reserves IBNR reserves reserves IBNR reserves
----------- ----------- ----------- ---------- ---------- -----------
(In thousands) (In thousands)
Automobile liability ......... $ 19,932 $ 19,111 $ 39,043 $ 14,227 $ 12,371 $ 26,598
Workers compensation ......... 25,253 19,037 44,290 10,336 6,945 17,281
Other liability .............. 5,535 33,058 38,593 4,069 9,324 13,393
Automobile physical damage ... 604 - 604 428 - 428
Property ..................... 62 11 73 25 8 33
Surety ....................... (22,108) 94 (22,014) (11,867) - (11,867)
Accident and health .......... 1 - 1 - - -
Inland marine ................ - - - - - -
----------- ----------- ----------- ---------- ---------- -----------
Total reserves .............. $ 29,279 $ 71,311 $ 100,590 $ 17,218 $ 28,648 $ 45,866
=========== =========== =========== ========== ========== ===========
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, 2007.
Insurance program Low High Recorded
------------------------------------------- --------- ---------- ----------
(In thousands)
Gross Reserves
--------------
Standard lines .......................... $104,808 $ 160,647 $ 110,098
Political subdivisions .................. 3,721 3,721 3,721
Homeowners .............................. 47 47 47
Surety bonds ............................ (22,014) (22,014) (22,014)
Involuntary workers compensation pools .. 5,704 5,704 5,704
Other ................................... 3,034 3,034 3,034
--------- ---------- ----------
$ 95,300 $ 151,139 $ 100,590
========= ========== ==========
Net Reserves
--------------
Standard lines .......................... $ 38,819 $ 83,584 $ 46,893
Political subdivisions .................. 1,358 2,064 2,033
Homeowners .............................. 35 35 35
Surety bonds ............................ (11,867) (11,867) (11,867)
Involuntary workers compensation pools .. 5,704 5,704 5,704
Other ................................... 3,068 3,068 3,068
--------- ---------- ----------
$ 37,117 $ 82,588 $ 45,866
========= ========== ==========
For the workers compensation portion of the standard lines program,
NAICO's actuaries selected the results of the incurred loss development
method for the 2006 and prior accident years. The 2007 accident year
selection was based on a judgmentally selected loss ratio. For the casualty
portion of this program, the actuaries relied on judgment in the selection
of ultimate losses for all accident years. The 2004 through 2007 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. Ultimate loss selections for older accident years assume unreported
losses are equal to case reserves as of December 31, 2007. 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 2007 loss reserve
analysis were similar to those used in the 2006 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.
PAGE 24
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.
Management believes that its unpaid losses and related reinsurance
recoverables are fairly stated as of December 31, 2007. 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, 2007, Chandler USA had a net operating loss
carryforward available for U.S. Federal income taxes of $1.3 million which
begins to expire in 2025. 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, 2007, had net operating
loss carryforwards available for Oklahoma state income taxes totaling
approximately $34.3 million which expire in the years 2008 through 2027.
A valuation allowance has been provided for the tax effect of the state
net operating loss since realization of such amount 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 $70.6 million, or 71%, of
NAICO's direct written and assumed premiums in 2007 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 equity
securities 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 through 2007 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 and 2007. 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,
--------------------------------
2005 2006 2007
---------- ---------- ----------
(Dollars in thousands)
INSURANCE PROGRAMS
- ----------------------------------------
STANDARD LINES
Net premiums earned .................. $ 54,979 $ 54,357 $ 62,342
Loss ratio ........................... 61.0% 74.0% 59.5%
POLITICAL SUBDIVISIONS
Net premiums earned .................. $ 6,690 $ 5,253 $ 3,436
Loss ratio ........................... 61.2% 51.3% 46.1%
HOMEOWNERS
Net premiums earned .................. $ 3,321 $ 5,353 $ 9
Loss ratio ........................... 39.3% 47.0% (560.0)%
SURETY BONDS
Net premiums earned .................. $ 669 $ 193 $ 186
Loss ratio ........................... (254.7)% (78.8)% 1,119.1%
OTHER (1)
Net premiums earned .................. $ 401 $ 548 $ 212
Loss ratio ........................... 29.7% 37.5% 307.2%
TOTAL
Net premiums earned .................. $ 66,060 $ 65,704 $ 66,185
Loss ratio ........................... 56.5% 69.2% 62.5%
- -------------------------
<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,
--------------------------------
2005 2006 2007
---------- ---------- ----------
(Dollars in thousands)
LINES OF INSURANCE
- ----------------------------------------
AUTOMOBILE LIABILITY
Net premiums earned .................. $ 19,126 $ 21,122 $ 26,469
Loss ratio ........................... 81.8% 99.5% 73.7%
WORKERS COMPENSATION
Net premiums earned .................. $ 16,475 $ 15,361 $ 17,861
Loss ratio ........................... 52.7% 63.3% 62.2%
OTHER LIABILITY
Net premiums earned .................. $ 18,052 $ 16,628 $ 15,137
Loss ratio ........................... 47.6% 56.9% 32.4%
AUTOMOBILE PHYSICAL DAMAGE
Net premiums earned .................. $ 5,807 $ 5,008 $ 6,096
Loss ratio ........................... 56.3% 62.6% 55.0%
PROPERTY
Net premiums earned .................. $ 5,594 $ 7,082 $ 279
Loss ratio ........................... 41.5% 41.3% 63.9%
SURETY
Net premiums earned .................. $ 669 $ 194 $ 186
Loss ratio ........................... (254.7)% (459.4)% 1,119.1%
INLAND MARINE
Net premiums earned .................. $ 337 $ 309 $ 157
Loss ratio ........................... 162.0% 30.0% 18.9%
TOTAL
Net premiums earned .................. $ 66,060 $ 65,704 $ 66,185
Loss ratio ........................... 56.5% 69.2% 62.5%
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 2005 2006 2007 2005 2006 2007
- -------------------------------- -------- -------- -------- -------- -------- --------
(In thousands)
Standard lines ................. $ 92,224 $ 91,153 $100,844 $ 54,979 $ 54,357 $ 62,342
Political subdivisions ......... 18,630 14,337 5,084 6,690 5,253 3,436
Homeowners ..................... 4,229 8,542 501 3,321 5,353 9
Surety bonds ................... 930 278 266 669 193 186
Other .......................... 406 550 214 401 548 212
-------- -------- -------- -------- -------- --------
TOTAL .......................... $116,419 $114,860 $106,909 $ 66,060 $ 65,704 $ 66,185
======== ======== ======== ======== ======== ========
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
---------------------------- ----------------------------
LINES OF INSURANCE 2005 2006 2007 2005 2006 2007
- -------------------------------- -------- -------- -------- -------- -------- --------
(In thousands)
Automobile liability ........... $ 28,031 $ 31,615 $ 39,298 $ 19,126 $ 21,122 $ 26,469
Workers compensation ........... 25,769 23,562 28,337 16,475 15,361 17,861
Other liability ................ 33,944 31,744 28,995 18,052 16,628 15,137
Automobile physical damage ..... 8,914 7,720 9,021 5,807 5,008 6,096
Property ....................... 17,102 18,335 745 5,594 7,082 279
Surety ......................... 930 278 266 669 194 186
Inland marine .................. 1,729 1,606 247 337 309 157
-------- -------- -------- -------- -------- --------
TOTAL .......................... $116,419 $114,860 $106,909 $ 66,060 $ 65,704 $ 66,185
======== ======== ======== ======== ======== ========
Gross premiums earned decreased 1% and 7% in 2006 and 2007,
respectively. The decrease in 2006 was primarily the result of NAICO's
continued efforts to improve underwriting profitability and to increased
competition within the Oklahoma school districts portion of the political
subdivisions program. The decrease in gross premiums earned in 2006 was
partially offset by an increase in gross premiums earned in the homeowners
program. The homeowners program was discontinued during 2006. The
decrease in 2007 gross premiums earned was due primarily to the transfer
of property and inland marine business in the standard lines and political
subdivisions programs to Praetorian Insurance Company ("Praetorian") as
explained further below and to the discontinuation of the homeowners
program. The decrease in gross premiums earned in 2007 was partially
offset by an increase in gross premiums earned in the standard lines
program. Gross premiums earned in Texas decreased 12% and 29% in 2006 and
2007, respectively, and gross premiums earned in Oklahoma decreased less
than 1% in 2006 and 14% in 2007.
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 are being written by 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. 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 is no longer required to
purchase reinsurance for the significant insured values associated with
this business.
Net premiums earned decreased 1% in 2006 and increased 1% in 2007. An
increase in net premiums earned in the homeowners program in 2006 partially
offset the decreases in net premiums earned in the political subdivisions,
standard lines and surety bond programs. Net premiums earned in the
standard lines program increased during 2007, but the increase was partially
offset by decreases in the political subdivisions and homeowners programs.
The decrease in net premiums earned for the business transferred to
Praetorian was much less than the decrease in gross premiums earned due to
the significant amounts of reinsurance that NAICO had purchased for this
business. The reinsurance was also cancelled which resulted in a
significant decrease in reinsurance premiums ceded during 2007.
PAGE 29
Gross premiums earned in the standard lines program decreased 1% in 2006
and increased 11% in 2007. Gross premiums earned for workers compensation
business decreased $2.3 million or 9% in 2006, but increased $5.1 million or
22% in 2007. NAICO has also increased premiums from trucking accounts in
2006 and 2007. Gross premiums earned from trucking accounts increased $8.9
million and $12.0 million in 2006 and 2007, respectively, while net premiums
earned increased $5.3 million and $7.7 million in these periods. Net
premiums earned in the standard lines program decreased 1% in 2006 and
increased 15% in 2007.
Gross premiums earned in the political subdivisions program decreased
23% and 65% in 2006 and 2007, respectively. The decrease in gross premiums
earned is due primarily to the transfer of the property and inland marine
business in this program to Praetorian as described previously, and to
increased competition related to Oklahoma school districts. Net premiums
earned decreased 21% and 35% in 2006 and 2007, respectively. The decrease
in net premiums earned was significantly less than the decrease in gross
premiums earned because of the significant amounts of reinsurance that NAICO
had purchased for the property and inland marine lines of business in this
program.
In 2005, NAICO began writing homeowner and dwelling policies in the
state of Texas through a managing general agent. NAICO discontinued this
program during 2006 due primarily to increased catastrophic exposures.
Gross premiums earned in the surety bond program decreased 70% and 4%
in 2006 and 2007, respectively. Net premiums earned decreased 71% and 4%
in 2006 and 2007, respectively. NAICO is no longer actively marketing its
surety bond program.
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, 2007, Chandler USA's investment portfolio consisted
primarily of fixed income U.S. Treasury and government agency bonds,
high-quality corporate bonds and certificates of deposit insured by the
FDIC, with approximately 34% 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 $6.6 million for the
accrual of prejudgment interest on a favorable jury verdict in civil
litigation regarding certain surety bond claims in 2006. During 2007,
NAICO reversed $4.1 million of the prejudgment interest income based on a
final judgment entered by the court. See Litigation and Note 10 of Notes
to Consolidated Financial Statements.
Net investment income, excluding interest income from related parties
and the prejudgment interest, increased 13% in both 2006 and 2007. Interest
income from related parties was $670,000, $792,000 and $941,000 during 2005,
2006 and 2007, respectively. The increases were due primarily to higher
interest rates and to an increase in the amount loaned to Chandler Insurance
during 2007. See Liquidity and Capital Resources.
Net realized investment gains were $383,000, $745,000 and $214,000 in
2005, 2006 and 2007, respectively.
The average net yield on the fixed maturity portfolio, including net
realized investment gains, was 3.4%, 3.6% and 4.0% in 2005, 2006 and 2007,
respectively. The average net yield on the fixed maturity portfolio,
excluding net realized investment gains, was 3.4% for 2005, 3.6% for 2006
and 3.8% for 2007. 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, 2007 was approximately $12.8
million. The average yield on the fixed maturity portfolio before
deducting investment expenses was 3.8% in 2005, 4.0% in 2006 and 4.2% in
2007, excluding net realized capital gains.
OTHER INCOME
Other income was $251,000, $317,000 and $1,916,000 during 2005, 2006
and 2007, respectively. The increase in 2007 was due to the transfer of
NAICO's property and inland marine business in the standard lines and
political subdivisions programs to Praetorian under a new arrangement
effective January 1, 2007. Under this arrangement, CIMI receives
commission income for the business it produces for Praetorian.
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 56.5%, 69.2% and 62.5% in 2005, 2006 and 2007,
respectively. Weather-related losses (net of applicable reinsurance) from
wind and hail were $475,000, $727,000 and $109,000 in 2005, 2006 and 2007,
respectively, and increased the respective loss ratios by 0.7, 1.1 and 0.2
percentage points.
NAICO experienced a significant amount of incurred losses related to
prior accident years during the 2005 and 2006 calendar years. Incurred
losses related to prior accident years decreased $2.5 million or 40% in
2006 and decreased $2.6 million or 69% in 2007. 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
--------------------------------
2005 2006 2007
---------- ---------- ----------
(In thousands)
Automobile liability ..................... $ 4,562 $ 3,028 $ (691)
Workers compensation ..................... 1,387 994 1,314
Other liability .......................... 1,330 590 (1,796)
Automobile physical damage ............... 255 261 65
Property ................................. 325 (47) (173)
Surety ................................... (1,844) (986) 2,074
Accident and health ...................... (26) 4 394
Inland marine ............................ 350 (15) 12
---------- ---------- ----------
$ 6,339 $ 3,829 $ 1,199
========== ========== ==========
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. During 2007, a portion of
these estimated recoveries were reduced based on a final judgment entered
by the court regarding certain surety bond claims. The reduction of the
estimated recoveries accounted for $1.8 million of the loss development
for surety business during 2007. 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
1999 1999 2000 2001 2002 2003 2004 2005 2006 Total
-------- -------- -------- --------- -------- -------- -------- -------- -------- ---------
(In thousands)
Reserves at beginning of 2005 .... $ 4,579 $ 610 $ 3,695 $ 3,242 $ 6,524 $ 8,833 $17,212 $ - $ - $ 44,695
Development during 2005 .......... (283) 664 1,582 (50) 1,992 1,777 657 - - 6,339
-------- -------- -------- --------- -------- -------- -------- -------- -------- ---------
Re-estimated reserves at
beginning of 2005 ............... $ 4,296 $ 1,274 $ 5,277 $ 3,192 $ 8,516 $10,610 $17,869 $ - $ - $ 51,034
======== ======== ======== ========= ======== ======== ======== ======== ======== =========
Reserves at beginning of 2006 .... $ 3,255 $ (255) $ 1,579 $ (2,444) $ 3,188 $ 5,896 $ 9,525 $19,805 $ - $ 40,549
Development during 2006 .......... 1,063 726 68 (1,678) 663 (996) 108 3,875 - 3,829
-------- -------- -------- --------- -------- -------- -------- -------- -------- ---------
Re-estimated reserves at
beginning of 2006 ............... $ 4,318 $ 471 $ 1,647 $ (4,122) $ 3,851 $ 4,900 $ 9,633 $23,680 $ - $ 44,378
======== ======== ======== ========= ======== ======== ======== ======== ======== =========
Reserves at beginning of 2007 .... $ 4,714 $ (447) $ 329 $(11,030) $ 1,610 $ 2,132 $ 3,492 $12,051 $29,230 $ 42,081
Development during 2007 .......... 1,004 935 230 2,292 515 (39) 1,249 345 (5,332) 1,199
-------- -------- -------- --------- -------- -------- -------- -------- -------- ---------
Re-estimated reserves at
beginning of 2007 ............... $ 5,718 $ 488 $ 559 $ (8,738) $ 2,125 $ 2,093 $ 4,741 $12,396 $23,898 $ 43,280
======== ======== ======== ========= ======== ======== ======== ======== ======== =========
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.
During 2007, NAICO experienced adverse loss development totaling $1.2
million primarily in the surety bond program. During 2007, a portion of
the estimated recoveries that were recorded in the surety bond program
during 2006 were reduced based on a final judgment entered by the court
regarding certain surety bond claims. The reduction of the estimated
recoveries accounted for $1.8 million of the loss development during
2007. The adverse loss development included approximately $356,000 for
provisions for potentially uncollectible reinsurance.
In the last six 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 2005, 2006 and 2007, NAICO incurred charges of
$108,000, $97,000 and $356,000, 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, 2005, 2006 and 2007:
YEAR ENDED DECEMBER 31,
--------------------------------
2005 2006 2007
---------- ---------- ----------
(In thousands)
Commissions expense .............................. $ 17,186 $ 15,933 $ 13,987
Other premium related assessments ................ 960 1,061 1,020
Premium taxes .................................... 2,205 2,020 2,014
Excise taxes ..................................... 272 272 280
Other expense .................................... 723 730 789
---------- ---------- ----------
Total direct expenses ............................ 21,346 20,016 18,090
Indirect underwriting expenses ................... 6,384 6,296 5,906
Commissions received from reinsurers ............. (15,891) (15,026) (11,176)
Adjustment for deferred acquisition costs ........ (1,168) 380 (273)
---------- ---------- ----------
Net policy acquisition costs ..................... $ 10,671 $ 11,666 $ 12,547
========== ========== ==========
Total gross direct and indirect expenses as a percentage of direct
written and assumed premiums were 23.0% in 2005, 23.3% in 2006 and 24.0% in
2007. For these periods, commission expense as a percentage of gross
written and assumed premiums was 14.3%, 14.1% and 14.0%.
Indirect underwriting expenses were 5.3%, 5.6% and 5.9% of total direct
written and assumed premiums in 2005, 2006 and 2007, respectively. The
increase in the 2007 percentage was due primarily to the transfer of the
property and inland marine business in the standard lines and political
subdivisions programs to Praetorian. The transfer reduced direct premiums
written by approximately $4.5 million in 2007. 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
31.6%, 31.1% and 31.4% in 2005, 2006 and 2007, respectively.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were 10.9%, 10.8% and 11.8% of gross
premiums earned and other income in 2005, 2006 and 2007, respectively. The
increase in the 2007 percentage was due primarily to the transfer of the
property and inland marine business in the standard lines and political
subdivisions programs to Praetorian. Gross premiums earned for property and
inland marine business in these programs decreased $10.9 million in 2007.
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 2006 and increased less than 1% in
2007. Substantially all of Chandler USA's interest expense is related to
its outstanding senior debentures and junior subordinated debentures. The
increase in 2006 was due primarily to the increase in interest rates during
the period, 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 35.6%, 32.9% and 11.6% for 2005, 2006
and 2007, respectively. The 2007 percentage decreased due primarily to the
impact of nondeductible expenses on the net loss before income taxes.
At December 31, 2007, Chandler USA had a net deferred tax asset of
$3.4 million including $455,000 related to federal net operating loss
carryforwards which begin to expire in 2025. 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, 2007, NAICO had statutory earned surplus of $12.5
million. Applying the Oklahoma statutory limits described above, the
maximum shareholder dividend NAICO may pay in 2008 without the approval of
the Oklahoma Department of Insurance is $5.0 million. NAICO paid
shareholder dividends to Chandler USA totaling $1.6 million during 2007.
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, 2007,
all of NAICO's fixed-maturity investments were rated A2 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, 2007, all of the investments of NAICO were in
fixed-maturity investments, certificates of deposit insured by the FDIC,
interest-bearing money market accounts, collateralized repurchase agreements
and common stock received in connection with an unaffiliated entity's
conversion to a for-profit corporation. 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 used $131,000 in cash from operations in 2005 and provided
$4.4 million and $8.7 million in cash from operations in 2006 and 2007,
respectively. 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. The cash provided by operations in 2007 included an increase in
unpaid losses and loss adjustment expenses of $17.3 million, but this was
offset in part by an increase in reinsurance recoverable on unpaid losses of
$10.6 million. These increases were primarily the result of reducing the
estimated recoveries on certain surety bond claims based on a final judgment
entered by the court. 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 $383,000, $745,000 and $214,000
during 2005, 2006 and 2007, respectively, from the sale of investments.
NAICO received proceeds of $2.5 million, $21.3 million and $17.6 million
during 2005, 2006 and 2007, respectively, from the sale of available for
sale securities prior to their maturity. The market value of NAICO's
available for sale fixed-income investments decreased by $1.6 million and
$1,000 in 2005 and 2006, respectively, and increased $2.2 million in 2007
due primarily to changes in interest rates experienced during this time.
The average maturity of NAICO's fixed maturity investments was 3.4 years
and 2.6 years at December 31, 2006 and 2007, 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, 2006 and
2007, Chandler USA had a receivable of $9.6 million and $11.5 million,
respectively, under the Credit Agreement, and Chandler USA earned $614,000,
$733,000 and $881,000 in interest income under the Credit Agreement during
2005, 2006 and 2007, 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, 2007, the total amount of cash
and investments restricted as a result of these arrangements was $8.0
million. In addition, NAICO has deposited $24.9 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 8.25% at December 31, 2007, 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, 2007, 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) ....................... $ 38,981 $ 42,140 $ 15,181 $ 4,288 $ 100,590
Future minimum rental payments
under operating leases ............. 568 541 - - 1,109
Guaranteed residual value of
operating lease (2) ................ - 1,518 - - 1,518
Capital leases ....................... 58 77 11 - 146
Debentures ........................... - - - 6,979 6,979
Junior subordinated debentures
issued to affiliated trusts ........ - - - 20,620 20,620
---------- --------- --------- --------- ---------
Total .............................. $ 39,607 $ 44,276 $ 15,192 $ 31,887 $ 130,962
========== ========= ========= ========= =========
- ----------------------------------------
<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
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. On August 1, 2006, the jury trial concluded in
Harris County, Texas, related to the construction of two gas processing
plants in Louisiana. The amounts the jury found owing to NAICO included
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.
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 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.
PAGE 36
On January 28, 2008, the court entered a final judgment denying Gulf
Liquid's claims against NAICO and Gulsby, denying all of NAICO's claims
against Gulf Liquids and Williams, and entering judgment for Gulsby against
Gulf Liquids for $15,651,927 plus interest at 7.25% compounded annually
from January 28, 2008 until paid. The court also ordered Gulf Liquids to
pay Gulsby's taxable court costs, estimated at $100,000. All parties may
appeal all or any of these judgments.
In the fourth quarter of 2007, as a result of this final judgment,
NAICO decreased the estimated recovery on the surety bond claims related
to the construction of the two gas processing plants which resulted in an
increase in losses and loss adjustment expenses incurred of $1.8 million.
Unpaid losses and loss adjustment expenses increased $12.7 million and
reinsurance recoverable on unpaid losses and loss adjustment expenses
increased $10.9 million as of December 31, 2007 as a result of decreasing
the estimated recovery. NAICO also decreased accrued interest income by
$4.5 million for its estimate of prejudgment interest income.
NEW ACCOUNTING STANDARDS
See Note 1 to Consolidated Financial Statements for a discussion of
recently issued accounting pronouncements.
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, 2007, substantially all of the investments of NAICO
were in fixed-maturity investments (rated A2 or A+ or better by Moody's
Investors Service, Inc. or Standard & Poor's, respectively), certificates
of deposit insured by the FDIC, interest-bearing money market accounts,
collateralized repurchase agreements and common stock received in
connection with an unaffiliated entity's conversion to a for-profit
corporation. 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
Fair value at Hypothetical change in
December 31, change in interest rate
---------------------- interest rate ----------------------
2006 2007 (bp=basis points) 2006 2007
---------- ---------- ----------------- ---------- ----------
(Dollars in thousands) (Dollars in thousands)
Fixed-maturity investments ... $ 66,379 $ 63,057 100 bp increase $ 64,392 $ 61,526
200 bp increase 62,520 60,068
100 bp decrease 68,431 64,644
200 bp decrease 70,613 66,312
The table above illustrates, for example, that an instantaneous 200
basis point increase in market interest rates at December 31, 2007 would
reduce the estimated fair value of NAICO's fixed-maturity investments by
approximately $3.0 million at that date.
PAGE 37
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, 2006 and 2007. 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, change in prices
---------------------- Hypothetical ----------------------
2006 2007 price change 2006 2007
---------- ---------- ----------------- ---------- ----------
(Dollars in thousands) (Dollars in thousands)
Equity securities ........ $ 1,921 $ 141 20% increase .... $ 2,305 $ 169
20% decrease .... 1,537 113
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, 2007, 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 9.34% at December 31, 2007. At December
31, 2007, the fair value of Chandler USA's junior subordinated debentures
was estimated to be $22.5 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
8.25% at December 31, 2007, 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.
PAGE 38
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(T). 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.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate
internal control over financial reporting, as such term is defined in Rule
13a-15(f) of the Securities Exchange Act of 1934 (the "Exchange Act"). Under
the supervision and with the participation of Chandler USA's management,
including our Chief Executive Officer and Chief Financial Officer, we
evaluated the effectiveness of our internal control over financial reporting
based on the framework in INTERNAL CONTROL-INTEGRATED FRAMEWORK issued by the
Committee of Sponsoring Organizations of the Treadway Commission. All
internal control systems, no matter how well designed, have inherent
limitations. Therefore, even those systems determined to be effective can
provide only reasonable assurance with respect to financial statement
preparation and presentation. Projections of any evaluation of effectiveness
to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate. Based on our evaluation under that
framework and applicable SEC rules, our management concluded that our
internal control over financial reporting was effective as of December 31,
2007.
This annual report does not include an attestation report of
Chandler USA's registered public accounting firm regarding internal
control over financial reporting. Management's report was not subject
to attestation by Chandler USA's registered public accounting firm
pursuant to temporary rules of the Securities and Exchange Commission
that permit Chandler USA to provide only management's report in this
annual report.
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 39
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 62 Chairman of the Board, Chief Executive Officer, Compensation
Committee Member and Director.
Mark T. Paden 51 President, Compensation Committee Member and Director.
Lance A. LaGere 27 Executive Vice President and Chief Operating Officer.
Richard L. Evans 61 Senior Vice President and Director.
R. Patrick Gilmore 56 Senior Vice President, Secretary, General Counsel and Director.
Mark C. Hart 52 Senior Vice President-Finance, Chief Financial Officer and Treasurer.
M. Steven Blain 50 Vice President-Administration.
Robert L. Rice 73 Audit Committee Chairman and Director.
W. Scott Martin 57 Audit Committee Member and Director.
William T. Keele 71 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 40
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, 2007.
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.
PAGE 41
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
2007, the following base salaries were approved for our named executive
officers:
PERCENTAGE
NAMED EXECUTIVE OFFICER 2007 BASE SALARY INCREASE
- -------------------------------------------- ---------------- ----------
W. Brent LaGere ............................ $ 561,830 2.8%
Mark T. Paden .............................. 343,726 3.0%
Richard L. Evans ........................... 285,381 3.0%
R. Patrick Gilmore ......................... 256,014 3.0%
Mark C. Hart ............................... 177,268 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 2007, the Compensation Committee awarded cash
bonuses to the named executive officers as shown in the Summary Compensation
Table that follows. These cash bonuses were paid during the years in which
they are reported.
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.
PAGE 42
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 2007 $ 549,255 $ 504,777 $ 1,432,763 $ 2,486,795
and CEO 2006 537,544 574,269 819,886 1,931,699
Mark T. Paden, President 2007 342,891 183,000 155,994 681,885
2006 332,904 563,432 98,204 994,540
Richard L. Evans, Senior 2007 284,688 8,000 22,972 315,660
Vice President - Claims 2006 276,396 - 21,383 297,779
R. Patrick Gilmore, Senior Vice President, 2007 251,043 8,000 14,867 273,910
Secretary and General Counsel 2006 243,731 - 13,102 256,833
Mark C. Hart, Senior Vice President - Finance, 2007 175,332 15,000 6,225 196,557
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 2007 $ 6,225 $ 100,280 $ 729,179 $ 597,079 $1,432,763
2006 6,100 75,953 429,622 308,211 819,886
Mark T. Paden 2007 6,225 15,882 72,953 60,934 155,994
2006 6,100 3,900 54,615 33,589 98,204
Richard L. Evans 2007 6,225 5,000 8,111 3,636 22,972
2006 6,100 5,000 6,557 3,726 21,383
R. Patrick Gilmore 2007 6,225 2,000 5,188 1,454 14,867
2006 6,100 2,000 3,474 1,528 13,102
Mark C. Hart 2007 6,225 - - - 6,225
2006 6,100 - - - 6,100
- ----------------------------------
<FN>
(1) The amounts shown in this column reflect company matching contributions under our 401(k) plan.
(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 for each year ($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.
PAGE 43
(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 insurance premiums, personal flights on company provided aircraft
and payments for miscellaneous personal expenses. 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, legal and estate planning services,
computer purchases, expenses related to personal investments, payments related to personally owned watercraft
of $99,009 in 2007 and payments for personal charges on personal credit cards of $316,529 during 2007.
(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 during the years indicated.
DIRECTOR COMPENSATION
FEES EARNED
NAME YEAR OR PAID IN CASH TOTAL
- ----------------------------------- -------- --------------- ----------
Robert L. Rice .................... 2007 $ 12,375 $ 12,375
2006 12,375 12,375
W. Scott Martin ................... 2007 11,250 11,250
2006 10,750 10,750
William T. Keele .................. 2007 11,250 11,250
2006 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 17, 2008 Compensation Committee:
W. Brent LaGere
Mark T. Paden
PAGE 44
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 29, 2008, 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 21.0%
Mark T. Paden .............................................. Class A Common Shares 125,165 20.0%
Series A Preferred Shares 17,610 4.9%
Richard L. Evans ........................................... Series A Preferred Shares 27,272 7.6%
Series B Preferred Shares 32,250 34.1%
R. Patrick Gilmore ......................................... Series B Preferred Shares 11,000 11.6%
Mark C. Hart ............................................... Series A Preferred Shares 3,528 1.0%
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 34.5%
Series B Preferred Shares 43,250 45.7%
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, 357,991 Series A Preferred Shares of Chandler Insurance,
94,696 Series B Preferred Shares of Chandler Insurance and 642,069 Series C Preferred Shares of Chandler Insurance
outstanding on February 29, 2008.
(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 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 45
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 29, 2008. 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 29, 2008.
(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.
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. 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 FDIC, 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. Interest has been paid through September 30, 2007. 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. CIMI paid
off the balance of this bank loan in December 2007. 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 46
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
2005, 2006 and 2007, Chandler USA incurred approximately $313,000, $308,000
and $302,000, respectively, in expenses associated with its use of this
property, including $10,000, $11,000 and $3,000 for reimbursement of
certain expenses, such as utility and similar expenses, for the years 2005,
2006 and 2007, 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 $178,900 and $186,400 for the years ended December 31, 2006
and 2007, 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 $21,000 and $18,500 for the
years ended December 31, 2006 and 2007, 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 $20,750 and $39,675 for the years ended
December 31, 2006 and 2007, respectively.
ALL OTHER FEES
There were no fees billed by Tullius Taylor Sartain & Sartain LLP
for professional services other than those reported in the categories
above for the years ended December 31, 2006 and 2007.
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 18.9% and 23.8% for the years ended December
31, 2006 and 2007, respectively.
PAGE 47
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, 2006 and
2007, 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, 2007,
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.
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)
PAGE 48
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)
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 49
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 17, 2008 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 17, 2008 /s/ W. Brent LaGere
----------------------------------------------------
W. Brent LaGere, Chairman of the Board,
Chief Executive Officer and Director
(Principal Executive Officer)
Date: March 17, 2008 /s/ Mark T. Paden
----------------------------------------------------
Mark T. Paden, President and Director
Date: March 17, 2008 /s/ Mark C. Hart
----------------------------------------------------
Mark C. Hart, Senior Vice President - Finance,
Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer)
Date: March 17, 2008 /s/ Richard L. Evans
----------------------------------------------------
Richard L. Evans, Senior Vice President and Director
Date: March 17, 2008 /s/ R. Patrick Gilmore
----------------------------------------------------
R. Patrick Gilmore, Senior Vice President,
Secretary, General Counsel and Director
Date: March 17, 2008 /s/ Robert L. Rice
----------------------------------------------------
Robert L. Rice, Director
Date: March 17, 2008 /s/ W. Scott Martin
----------------------------------------------------
W. Scott Martin, Director
Date: March 17, 2008 /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, 2006 and 2007 ................................. F-2
Consolidated Statements of Operations for the years ended
December 31, 2005, 2006 and 2007 ......................................................... F-3
Consolidated Statements of Comprehensive Income for the years ended
December 31, 2005, 2006 and 2007 ......................................................... F-4
Consolidated Statements of Cash Flows for the years ended
December 31, 2005, 2006 and 2007 ......................................................... F-5
Consolidated Statements of Shareholder's Equity for the years ended
December 31, 2005, 2006 and 2007 ......................................................... F-6
Notes to Consolidated Financial Statements ................................................... F-7 through F-26
Report of Independent Registered Public Accounting Firm on Consolidated Financial Statements
and Financial Statement Schedules ........................................................ F-27
SCHEDULES
I Summary of Investments - Other Than Investments in Related Parties .................. F-28
II Condensed Financial Information of Registrant ....................................... F-29 through F-31
III Supplementary Insurance Information ................................................. F-32
IV Reinsurance ......................................................................... F-33
V Valuation and Qualifying Accounts ................................................... F-34
VI Supplemental Information (for property-casualty insurance underwriters) ............. F-35
PAGE F-2
CHANDLER (U.S.A.), INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands except share amounts)
DECEMBER 31,
-----------------------
2006 2007
---------- ----------
ASSETS
Investments
Fixed maturities available for sale, at fair value
Restricted (amortized cost $19,830 and $32,416 in 2006 and 2007, respectively) ......... $ 19,151 $ 32,670
Unrestricted (amortized cost $48,557 and $30,484 in 2006 and 2007, respectively) ....... 47,228 30,387
Equity securities at fair value (cost $1,587 and $0 in 2006 and 2007, respectively) ...... 1,921 141
Short-term investments ................................................................... - 1,045
---------- ----------
Total investments ...................................................................... 68,300 64,243
Cash and cash equivalents ($450 and $146 restricted in 2006 and 2007, respectively) ........ 21,403 32,956
Accrued investment income .................................................................. 5,022 874
Premiums receivable, less allowance for non-collection
of $170 and $134 at 2006 and 2007, respectively .......................................... 31,008 28,128
Reinsurance recoverable on paid losses ..................................................... 1,087 1,100
Reinsurance recoverable on unpaid losses, less allowance for non-collection
of $130 and $239 at 2006 and 2007, respectively .......................................... 25,588 36,036
Reinsurance recoverable on unpaid losses from related parties .............................. 15,584 18,688
Prepaid reinsurance premiums ............................................................... 7,603 3,105
Prepaid reinsurance premiums to related parties ............................................ 13,506 12,928
Deferred policy acquisition costs .......................................................... 845 1,118
Property and equipment, net ................................................................ 8,457 8,255
Amounts due from related parties ........................................................... 9,584 11,506
State insurance licenses, net .............................................................. 3,745 3,745
Other assets ............................................................................... 11,040 11,685
---------- ----------
Total assets ............................................................................... $ 222,772 $ 234,367
========== ==========
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Unpaid losses and loss adjustment expenses ............................................... $ 83,253 $ 100,590
Unearned premiums ........................................................................ 53,217 46,389
Policyholder deposits .................................................................... 7,663 7,947
Accrued taxes and other payables ......................................................... 5,119 5,777
Premiums payable ......................................................................... 1,955 2,263
Premiums payable to related parties ...................................................... 1,002 198
Debentures ............................................................................... 6,979 6,979
Junior subordinated debentures issued to affiliated trusts ............................... 20,620 20,620
---------- ----------
Total liabilities ...................................................................... 179,808 190,763
---------- ----------
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 ...................................................................... (16,517) (17,179)
Accumulated other comprehensive income (loss):
Unrealized gain (loss) on investments available for sale, net of deferred income taxes.. (1,105) 197
---------- ----------
Total shareholder's equity ............................................................. 42,964 43,604
---------- ----------
Total liabilities and shareholder's equity ................................................. $ 222,772 $ 234,367
========== ==========
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,
--------------------------------------
2005 2006 2007
------------ ------------ ------------
Premiums and other revenues
Direct premiums written and assumed .................................... $ 120,344 $ 113,043 $ 100,081
Reinsurance premiums ceded ............................................. (23,060) (21,098) (7,690)
Reinsurance premiums ceded to related parties .......................... (27,158) (27,156) (27,959)
------------ ------------ ------------
Net premiums written and assumed . .................................... 70,126 64,789 64,432
Decrease (increase) in unearned premiums ............................... (4,066) 915 1,753
------------ ------------ ------------
Net premiums earned ................................................... 66,060 65,704 66,185
Investment income (loss), net ....... ................................... 2,798 9,801 (572)
Interest income, net from related parties ............................... 670 792 941
Realized investment gains, net .......................................... 383 745 214
Other income ............................................................ 251 317 1,916
------------ ------------ ------------
Total premiums and other revenues ..................................... 70,162 77,359 68,684
------------ ------------ ------------
Operating costs and expenses
Losses and loss adjustment expenses, net of amounts ceded
to related parties of $13,200, $14,007 and $16,808
in 2005, 2006 and 2007, respectively .................................. 37,324 45,473 41,393
Policy acquisition costs, net of ceding commissions received
from related parties of $10,498, $10,445 and $10,633
in 2005, 2006 and 2007, respectively .................................. 10,671 11,666 12,547
General and administrative expenses .................................... 12,749 12,469 12,790
Interest expense ....................................................... 2,535 2,690 2,703
------------ ------------ ------------
Total operating costs and expenses .................................... 63,279 72,298 69,433
------------ ------------ ------------
Income (loss) before income taxes ....................................... 6,883 5,061 (749)
Federal income tax benefit (provision) .................................. (2,450) (1,665) 87
------------ ------------ ------------
Income (loss) ........................................................... $ 4,433 $ 3,396 $ (662)
============ ============ ============
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,
--------------------------------------
2005 2006 2007
------------ ------------ ------------
Net income (loss) ............................................................ $ 4,433 $ 3,396 $ (662)
------------ ------------ ------------
Other comprehensive income (loss), before income tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period .................... (1,040) 566 2,187
Less: Reclassification adjustment for gains included in net income (loss) .. (383) (745) (214)
------------ ------------ ------------
Other comprehensive income (loss), before income tax ......................... (1,423) (179) 1,973
Income tax benefit (provision) related to items of other
comprehensive income (loss) ................................................. 484 61 (671)
------------ ------------ ------------
Other comprehensive income (loss), net of income tax ......................... (939) (118) 1,302
------------ ------------ ------------
Comprehensive income ......................................................... $ 3,494 $ 3,278 $ 640
============ ============ ============
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,
--------------------------------------
2005 2006 2007
------------ ------------ ------------
OPERATING ACTIVITIES
Net income (loss) ...................................................... $ 4,433 $ 3,396 $ (662)
Add (deduct):
Adjustments to reconcile net income (loss) to cash
provided by (applied to) operating activities:
Realized investment gains, net ....................................... (383) (745) (214)
Net (gains) losses on sale of property and equipment ................. (2) 20 (6)
Amortization and depreciation ........................................ 1,486 1,379 1,431
Provision for non-collection of premiums ............................. 176 80 19
Provision for non-collection of reinsurance recoverables ............. 108 97 356
Net change in non-cash balances relating to operating activities:
Accrued investment income ........................................... 28 (4,135) 4,148
Premiums receivable ................................................. (5,713) (2,742) 2,861
Reinsurance recoverable on paid losses .............................. (875) 1,647 (260)
Reinsurance recoverable on paid losses from related parties ......... 83 - -
Reinsurance recoverable on unpaid losses ............................ (4,263) 29,164 (10,557)
Reinsurance recoverable on unpaid losses from related parties ....... (1,127) (1,300) (3,104)
Prepaid reinsurance premiums ........................................ 74 2,160 4,498
Prepaid reinsurance premiums to related parties ..................... 68 (1,259) 578
Deferred policy acquisition costs ................................... (1,168) 380 (273)
Other assets ........................................................ 2,676 2,129 (1,373)
Unpaid losses and loss adjustment expenses .......................... 1,308 (26,288) 17,337
Unearned premiums ................................................... 3,925 (1,817) (6,828)
Policyholder deposits ............................................... 772 1,979 284
Accrued taxes and other payables .................................... (357) (441) 997
Premiums payable .................................................... (1,493) (226) 308
Premiums payable to related parties ................................. 113 889 (804)
------------ ------------ ------------
Cash provided by (applied to) operating activities ................... (131) 4,367 8,736
------------ ------------ ------------
INVESTING ACTIVITIES
Short-term investments:
Purchases ............................................................. - - (1,330)
Maturities ............................................................ - - 285
Unrestricted fixed maturities available for sale:
Purchases ............................................................. (6,158) (995) (13,585)
Sales ................................................................. 2,091 - 10,120
Maturities ............................................................ 1,770 5,809 8,588
Equity securities available for sale:
Purchases ............................................................. (500) (13,620) (5,811)
Sales ................................................................. 380 21,336 7,457
Cost of property and equipment purchased ............................... (413) (688) (696)
Proceeds from sale of property and equipment ........................... 70 71 50
Investment in limited partnership ...................................... - (502) -
------------ ------------ ------------
Cash provided by (applied to) investing activities ................... (2,760) 11,411 5,078
------------ ------------ ------------
FINANCING ACTIVITIES
Payments and loans from related parties ................................ 2,513 1,747 2,164
Payments and loans to related parties .................................. (982) (1,971) (4,086)
Bank loan proceeds ..................................................... - 500 -
Payments on bank loan .................................................. - (161) (339)
------------ ------------ ------------
Cash provided by (applied to) financing activities ................... 1,531 115 (2,261)
------------ ------------ ------------
Increase (decrease) in cash and cash equivalents during the period ..... (1,360) 15,893 11,553
Cash and cash equivalents at beginning of period ....................... 6,870 5,510 21,403
------------ ------------ ------------
Cash and cash equivalents at end of period ............................. $ 5,510 $ 21,403 $ 32,956
============ ============ ============
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, 2005 ......... $ 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
----------- ----------- ----------- ------------- -------------
Net loss ......................... - - (662) - (662)
Change in unrealized loss on
investments available for
sale, net of income tax ......... - - - 1,302 1,302
----------- ----------- ----------- ------------- -------------
Balance, December 31, 2007 ....... $ 2 $ 60,584 $ (17,179) $ 197 $ 43,604
=========== =========== =========== ============= =============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
PAGE F-7
CHANDLER (U.S.A.), INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2006 AND 2007
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.
(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:
2006 2007
---------- ----------
(In thousands)
Real estate and improvements ... $ 11,889 $ 11,967
Other property and equipment ... 8,408 8,577
---------- ----------
20,297 20,544
Accumulated depreciation ....... (11,840) (12,289)
---------- ----------
$ 8,457 $ 8,255
========== ==========
Depreciation expense was approximately $815,000, $780,000 and
$854,000 for 2005, 2006 and 2007, 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 2006 and 2007 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:
2006 2007
---------- ----------
(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,
--------------------------------
2005 2006 2007
---------- ---------- ----------
(In thousands)
Cash payments during the year for:
Interest ....................................... $ 2,447 $ 2,608 $ 2,649
Income taxes ................................... 160 - 25
Transfers to restricted securities, net .......... $ (3,429) $ (8,127) $ (12,726)
(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.
PAGE F-10
(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.
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 No. 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 No. 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 No. 133. SFAS No. 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. Chandler USA adopted
SFAS No. 155 effective January 1, 2007. The adoption of SFAS No.
155 did not have a material impact on Chandler USA's 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 No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of
Liabilities." SFAS No. 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 are required. Chandler USA adopted SFAS No. 156
effective January 1, 2007. The adoption of SFAS No. 156 did not
have a material impact on Chandler USA's 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 No. 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 adopted FIN No. 48 effective
January 1, 2007. The adoption of FIN No. 48 did not have a
material impact on Chandler USA's 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 has adopted SFAS No. 158 effective
December 31, 2006. The adoption of SFAS No. 158 did not have a
material impact on Chandler USA's consolidated financial
statements.
PAGE F-11
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.
In March 2007, the FASB ratified Emerging Issues Task Force
Issue ("EITF") No. 06-10, "Accounting for Deferred Compensation
and Post Retirement Benefit Aspects of Collateral Assignment
Split-Dollar Life Insurance Arrangements." EITF No. 06-10
provides guidance for determining a liability for the
postretirement benefit obligation and for recognition and
measurement of the associated asset based on the terms of the
collateral assignment agreement. EITF No. 06-10 is effective for
fiscal years beginning after December 15, 2007. Chandler USA has
evaluated EITF No. 06-10 and has determined that its adoption is
not expected to have a material impact on its consolidated
financial statements.
In December 2007, the FASB issued SFAS No. 141(R), "Business
Combinations," which requires most identifiable assets,
liabilities, non-controlling interests, and goodwill acquired in
a business combination to be recorded at full fair value. Under
SFAS No. 141(R), all business combinations will be accounted for
by applying the acquisition method (referred to as the purchase
method in SFAS No. 141, "Business Combinations"). SFAS No. 141
(R) is effective for fiscal years beginning on or after December
15, 2008 and is to be applied to business combinations occurring
after the effective date. Chandler USA does not expect the
adoption of SFAS No. 141(R) to have a material impact on its
consolidated financial statements.
In December 2007, the FASB issued FASB No. 160,
"Noncontrolling Interests in Consolidated Financial Statements,"
which requires noncontrolling interests (previously referred to as
minority interests) to be treated as a separate component of
equity, not as a liability or other item outside of permanent
equity. SFAS No. 160 is effective for fiscal years beginning on
or after December 15, 2008. Chandler USA does not expect the
adoption of SFAS No. 160 to have a material impact on its
consolidated financial statements.
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,
--------------------------------
2005 2006 2007
---------- ---------- ----------
(In thousands)
Interest on fixed-maturity investments ................... $ 2,791 $ 2,829 $ 2,818
Interest on short-term investments and cash equivalents .. 159 574 1,069
Dividend income on equity securities ..................... 135 58 11
Prejudgment interest related to litigation ............... - 6,648 (4,148)
Investment expenses ...................................... (287) (308) (322)
---------- ---------- ----------
Investment income, net ................................. 2,798 9,801 (572)
---------- ---------- ----------
Realized gains, net - fixed-maturity investments ......... 3 - 154
Realized gains, net - equity securities .................. 380 745 60
---------- ---------- ----------
Realized investments gains, net ........................ 383 745 214
---------- ---------- ----------
$ 3,181 $ 10,546 $ (358)
========== ========== ==========
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. During 2007, NAICO
reversed $4.1 million of the prejudgment interest income based on a final
judgment entered by the court. See Note 10 for more information related
to this litigation.
Investment expenses include $137,000, $164,000 and $193,000 for the
years ended December 31, 2005, 2006 and 2007, respectively, in expense to
subsidize a premium finance program for certain insureds of NAICO with an
unaffiliated premium finance company.
PAGE F-12
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, 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
========== ========== ========== ========== ==========
GROSS GROSS
UNREALIZED UNREALIZED FAIR CARRYING
DECEMBER 31, 2007 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 .......................... $ 38,723 $ 516 $ (67) $ 39,172 $ 39,172
Corporate obligations .................... 18,703 49 (246) 18,506 18,506
Public utilities ......................... 4,287 2 (58) 4,231 4,231
Mortgage-backed securities ............... 1,187 - (39) 1,148 1,148
---------- ---------- ---------- ---------- ----------
$ 62,900 $ 567 $ (410) $ 63,057 $ 63,057
========== ========== ========== ========== ==========
EQUITY SECURITIES:
Corporate stock .......................... $ - $ 141 $ - $ 141 $ 141
========== ========== ========== ========== ==========
At December 31, 2006 and 2007, Chandler USA did not hold any fixed
maturity investments that exceeded 10% of shareholder's equity.
The fair value of Chandler USA's investments with sustained gross
unrealized losses at December 31, 2007 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 .......... $ - $ - $ 14,636 $ (67) $ 14,636 $ (67)
Corporate securities ................. - - 15,449 (246) 15,449 (246)
Public utilities ..................... - - 2,544 (58) 2,544 (58)
Mortgage-backed securities ........... - - 1,147 (39) 1,147 (39)
----------- ---------- ----------- ---------- ----------- ----------
$ - $ - $ 33,776 $ (410) $ 33,776 $ (410)
=========== ========== =========== ========== =========== ==========
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, 2007.
PAGE F-13
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, 2007 are shown below:
AVAILABLE FOR SALE
------------------------
AMORTIZED
COST FAIR VALUE
------------ ----------
(In thousands)
Due in one year or less .......................... $ 17,743 $ 17,663
Due after one year through five years ............ 30,472 30,592
Due after five years through ten years ........... 11,812 11,966
Due after ten years .............................. 1,686 1,688
------------ ----------
61,713 61,909
Mortgage-backed securities ....................... 1,187 1,148
------------ ----------
$ 62,900 $ 63,057
============ ==========
Realized gains and losses from sales of investments are shown below:
2005 2006 2007
-------- -------- --------
(In thousands)
FIXED MATURITIES:
Gross realized gains ............................. $ 20 $ - $ 191
Gross realized losses ............................ (17) - (37)
-------- -------- --------
Total net realized gains ........................ $ 3 $ - $ 154
======== ======== ========
EQUITY SECURITIES:
Gross realized gains ............................. $ 380 $ 855 $ 229
Gross realized losses ............................ - (110) (169)
-------- -------- --------
Total net realized gains ........................ $ 380 $ 745 $ 60
======== ======== ========
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, 2006 and 2007, the carrying value of these deposits totaled
approximately $7.7 million and $8.0 million, respectively. In addition,
NAICO has deposited $24.9 million of cash and investments into a trust
account as collateral for a reinsurance agreement in which NAICO is the
assuming reinsurer.
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 $13.2 million and $11.1 million at December 31, 2006 and 2007,
respectively. Included in these recoverable amounts were net recoverables
of $10.8 million and $10.1 million in 2006 and 2007, respectively, 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. NAICO may or may not recover the above estimated recoveries
and could incur significant costs in collecting these recoverables.
PAGE F-14
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,
----------------------------------
2005 2006 2007
---------- ---------- ----------
(In thousands)
Net balance at beginning of year .......................... $ 44,695 $ 40,549 $ 42,081
---------- ---------- ----------
Net losses and loss adjustment expenses incurred related to:
Current year ............................................ 30,985 41,644 40,194
Prior years ............................................. 6,339 3,829 1,199
---------- ---------- ----------
Total ................................................. 37,324 45,473 41,393
---------- ---------- ----------
Net paid losses and loss adjustment expenses related to:
Current year ............................................ (11,171) (12,403) (12,494)
Prior years ............................................. (30,299) (31,538) (25,114)
---------- ---------- ----------
Total ................................................. (41,470) (43,941) (37,608)
---------- ---------- ----------
Net balance at end of year ................................ $ 40,549 $ 42,081 $ 45,866
========== ========== ==========
NAICO experienced a significant amount of incurred losses related to
prior accident years during the 2005 and 2006 calendar years. Incurred
losses related to prior accident years decreased $2.5 million or 40% in
2006 and decreased $2.6 million or 69% in 2007. 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 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.
During 2007, NAICO experienced adverse loss development totaling $1.2
million primarily in the surety bond program. During 2007, a portion of the
estimated recoveries that were recorded in the surety bond program during
2006 were reduced based on a final judgment entered by the court regarding
certain surety bond claims. The reduction of the estimated recoveries
accounted for $1.8 million of the loss development during 2007. The adverse
loss development included approximately $356,000 for provisions for
potentially uncollectible reinsurance.
PAGE F-15
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, 2007, there were $6,979,000 principal amount of the Debentures
outstanding. As of December 31, 2007, Chandler USA has capitalized
$214,000 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, 2007, Chandler USA was
in compliance with all covenants.
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.
PAGE F-16
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 9.34% at December 31, 2007. 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 9.34% at December 31,
2007. 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, 2007, issuance costs in the
amount of $622,000 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.
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 and statutory capital and surplus of NAICO are as
follows:
2005 2006 2007
-------- -------- --------
(In thousands)
Statutory net income .............. $ 5,915 $ 3,789 $ 1,037
Statutory capital and surplus ..... $ 47,285 $ 51,663 $ 50,250
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, $404,000 and $305,000 at December 31, 2005, 2006 and 2007,
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.
PAGE F-17
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, 2006 and 2007.
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 2008
without the approval of the Oklahoma Department of Insurance is
approximately $5.0 million. NAICO paid cash shareholder dividends to
Chandler USA totaling $1.6 million in 2007. NAICO did not pay any
shareholder dividends during 2005 and 2006.
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 $12.5
million as of December 31, 2007). NAICO paid approximately $4,000 in
policyholder dividends during 2006, respectively. NAICO did not pay any
policyholder dividends during 2005 or 2007.
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:
2005 2006 2007
---------- ---------- ----------
(In thousands)
Computed income tax provision (benefit) at 34% ................... $ 2,340 $ 1,721 $ (255)
Increase (decrease) in income taxes resulting from:
Utilization of capital loss carryforward ....................... (104) (253) (73)
Nondeductible meals and entertainment expenses ................. 164 163 150
Other nondeductible expenses ................................... 50 34 91
---------- ---------- ----------
Federal income tax provision (benefit) ........................... $ 2,450 $ 1,665 $ (87)
========== ========== ==========
U.S. Federal income tax provision (benefit) consists of:
CURRENT DEFERRED TOTAL
---------- ---------- ----------
(In thousands)
2005 ............................................................. $ 160 $ 2,290 $ 2,450
2006 ............................................................. - 1,665 1,665
2007 ............................................................. - (87) (87)
PAGE F-18
Deferred income tax provision (benefit) relating to temporary
differences includes the following components:
2005 2006 2007
---------- ---------- ----------
(In thousands)
Loss reserve discounts ........................................... $ 454 $ 66 $ 9
Unearned premiums ................................................ (256) 62 119
Deferred policy acquisition costs ................................ 397 (129) 93
Investment in limited partnerships ............................... (126) (152) (40)
Alternative minimum tax .......................................... (160) - -
Reserve for uncollectible premiums receivable .................... (36) 18 12
Depreciation and lease expense ................................... (106) (70) (49)
Discount on fixed maturity investments ........................... 26 23 21
Accrual of prejudgment interest income ........................... - 1,410 (1,410)
Net operating loss carryforwards ................................. 2,076 530 1,118
Other ............................................................ 21 (93) 40
---------- ---------- ----------
$ 2,290 $ 1,665 $ (87)
========== ========== ==========
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:
2006 2007
------------ ------------
(In thousands)
Deferred tax assets:
Loss reserve discounts ...................................... $ 2,049 $ 2,040
Unearned premiums ........................................... 2,183 2,064
Compensated absences ........................................ 227 191
Net operating loss carryforwards - federal .................. 1,572 455
Net operating loss carryforwards - state .................... 3,230 2,057
Net capital loss carryforward ............................... 818 -
Investment in limited partnership ........................... 278 318
Unrealized loss on investments available for sale ........... 569 -
Other ....................................................... 262 306
Valuation allowance ......................................... (4,048) (2,057)
------------ ------------
Total deferred tax assets ..................................... 7,140 5,374
------------ ------------
Deferred tax liabilities:
Depreciation and lease expense .............................. 1,300 1,252
Accrual of prejudgment interest income ...................... 1,410 -
Deferred policy acquisition costs ........................... 287 380
Unrealized gain on investments available for sale ........... - 101
Other ....................................................... 150 194
------------ ------------
Total deferred tax liabilities ................................ 3,147 1,927
------------ ------------
Net deferred tax assets ....................................... $ 3,993 $ 3,447
============ ============
At December 31, 2007, Chandler USA had a net operating loss
carryforward available for U.S. Federal income taxes of $1.3 million
which begins to expire in 2025. 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, 2007, had net operating
loss carryforwards available for Oklahoma state income taxes totaling
approximately $34.3 million which expire in the years 2008 through 2027.
At December 31, 2006, Chandler USA had a capital loss carryforward for U.S.
Federal income taxes of $2.4 million. The balance of the capital loss
carryforward expired 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.
PAGE F-19
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 $6,225 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
$315,000, $307,000 and $288,000 for 2005, 2006 and 2007, 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.
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, 2006 and 2007. The estimated fair values of
Chandler USA's fixed-maturity and equity security investments are disclosed
at Note 2. At December 31, 2007, 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, 2007 was 9.34%. At
December 31, 2007, the fair value of Chandler USA's junior subordinated
debentures was estimated to be $22.5 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.
PAGE F-20
The trial in the Harris County cases began in late April 2006, and
concluded August 1, 2006. The jury found in favor of NAICO and 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 included $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.
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 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.
On January 28, 2008, the court entered a final judgment denying
Gulf Liquid's claims against NAICO and Gulsby, denying all of NAICO's
claims against Gulf Liquids and Williams, and entering judgment for
Gulsby against Gulf Liquids for $15,651,927 plus interest at 7.25%
compounded annually from January 28, 2008 until paid. The court also
ordered Gulf Liquids to pay Gulsby's taxable court costs, estimated at
$100,000. All parties may appeal all or any of these judgments.
In the fourth quarter of 2007, as a result of this final judgment,
NAICO decreased the estimated recovery on the surety bond claims related
to the construction of the two gas processing plants which resulted in
an increase in losses and loss adjustment expenses incurred of $1.8
million. Unpaid losses and loss adjustment expenses increased $12.7
million and reinsurance recoverable on unpaid losses and loss adjustment
expenses increased $10.9 million as of December 31, 2007 as a result of
decreasing the estimated recovery. NAICO also decreased accrued interest
income by $4.5 million for its estimate of prejudgment interest income.
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.
PAGE F-21
NAICO has structured separate reinsurance programs for workers
compensation, casualty (including automobile liability, general and products
liability, umbrella liability and related professional liability), automobile
physical damage and construction surety bonds. NAICO discontinued its
property reinsurance program effective January 1, 2007 due to the transfer
of its commercial property business to another insurance company. 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. The majority of NAICO's reinsurance programs renew on July 1 of
each year. At the present time, NAICO expects to renew the reinsurance
programs that expire on July 1, 2008.
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 2005, 2006 and 2007, NAICO incurred charges of
$108,000, $97,000 and $356,000, respectively, in adjustments to ceded
losses and loss adjustment expenses for amounts deemed uncollectible.
The effect of reinsurance on premiums written and earned was as follows:
2005 2006 2007
----------------------- ----------------------- -----------------------
WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED
----------- ---------- ----------- ---------- ----------- ----------
(In thousands)
Direct ........... $ 119,051 $ 115,849 $ 104,037 $ 109,637 $ 85,836 $ 93,487
Assumed .......... 1,293 570 9,006 5,223 14,245 13,422
Ceded ............ (50,218) (50,359) (48,254) (49,156) (35,649) (40,724)
----------- ---------- ----------- ---------- ----------- ----------
Net premiums ..... $ 70,126 $ 66,060 $ 64,789 $ 65,704 $ 64,432 $ 66,185
=========== ========== =========== ========== =========== ==========
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 $50.3 million,
$10.2 million and $39.5 million for 2005, 2006 and 2007, respectively.
SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK
NAICO conducts its business through individual independent insurance
agencies and underwriting managers. NAICO 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, 2006 and
2007 were $31.0 million and $28.1 million, respectively. Receivables for
deductibles, in most cases, are secured by cash deposits and letters of
credit. At December 31, 2007, NAICO maintained custody of such letters of
credit securing these and other transactions totaling approximately $26.9
million, which is a reasonable estimate of their fair value. These letters
of credit are not reflected in the accompanying consolidated financial
statements. During 2005 and 2006, one unaffiliated independent insurance
agent produced approximately 12% of NAICO's direct written and assumed
premiums in each year. There were no unaffiliated independent insurance
agents that produced 10% or more of NAICO's direct written and assumed
premiums during 2007.
PAGE F-22
Approximately $32.3 million, or 45% of NAICO's reinsurance recoverables
and prepaid reinsurance premiums at December 31, 2007 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.
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, 2007.
CEDED REINSURANCE
NET PREMIUMS FOR A.M. BEST
REINSURANCE THE YEAR ENDED COMPANY
NAME OF REINSURER RECOVERABLE (1) DECEMBER 31, 2007 RATING
- ------------------------------------------------------------- --------------- ------------------ -----------
(Dollars in thousands)
Chandler Insurance ....................................... $ 31,616 $ 27,959 (2)
Employers Reinsurance Corporation ........................ 17,158 (1,354) A+
Swiss Reinsurance America Corporation .................... 17,078 431 A+
Markel Insurance Company ................................. 2,718 1,785 A
Transatlantic Reinsurance Company ........................ 2,380 1,863 A+
--------------- ------------------
Top five reinsurers ................................. $ 70,950 $ 30,684
=============== ==================
All reinsurers ...................................... $ 71,857 $ 35,649
=============== ==================
Percentage of total represented by top five reinsurers ... 99% 86%
- -------------------------------------------------------------
<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, 2007.
(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, 2007, Chandler Insurance had
cash and investments, including accrued interest, with a fair value of $31.6 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 $914,000 and $903,000
at December 31, 2006 and 2007, 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 $2,870,000 and $2,847,000 at December 31, 2006
and 2007, 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, 2007, Chandler USA's subsidiaries were committed under
noncancellable operating and capital leases for certain equipment and office
space. Rental payments under these leases were $780,000, $777,000 and
$648,000 in 2005, 2006 and 2007, respectively. Future minimum lease payments
are as follows:
(In thousands)
2008 .......................... $ 626
2009 .......................... 507
2010 .......................... 110
2011 .......................... 11
2012 .......................... -
--------------
$ 1,254
==============
During March 2001, Chandler USA entered into a $3.8 million sale and
leaseback transaction for certain owned equipment for three years. 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 8.25% at December 31, 2007. 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. 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. Interest on the debentures has been paid through September 30,
2007. 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. CIMI paid off the balance of this bank loan in December
2007. 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 $313,000, $308,000 and
$302,000 in expenses associated with this property during 2005, 2006 and
2007, respectively, including $10,000, $11,000 and $3,000 for
reimbursement of certain expenses, such as utility and similar expenses,
for the years 2005, 2006 and 2007, 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,
2006 and 2007, Chandler USA had a receivable of $9.6 million and $11.5
million, respectively, under the Credit Agreement, and Chandler USA earned
$614,000, $733,000 and $881,000 in interest income under the Credit Agreement
during 2005, 2006 and 2007, respectively.
NOTE 13. SEGMENT INFORMATION
Chandler USA has two reportable operating segments: property and
casualty insurance and agency. The segments are managed separately due to
the differences in the nature of the insurance products and services sold.
Following the sale of a subsidiary in 2002 that was engaged in agency
operations, agency operations were not significant on a consolidated basis
and therefore not reported as a separate segment. Effective January 1,
2007, NAICO transferred its existing property and inland marine business
in its standard lines and political subdivisions programs to Praetorian
Insurance Company ("Praetorian") through an arrangement between Praetorian
and CIMI. Under this arrangement, CIMI receives commission income for the
business it produces for Praetorian. Since this new arrangement resulted
in a significant increase in agency revenues, the agency segment is now
reported separately.
The agency segment accounted for 0.0%, 4.1% and 7.0% of 2005, 2006 and
2007 consolidated revenues before intersegment eliminations, respectively.
CIMI is an underwriting manager and wholesaler that offers multiple
insurance products for businesses in various industries and political
subdivisions. A large portion of certain classes of business produced by
CIMI is placed with NAICO. Management evaluates the agency segment's
performance on the basis of commission income generated and income before
income taxes.
Chandler USA accounts for intercompany sales and transactions as if
they were to third parties and attempts to set fees consistent with those
that would apply in arm's length transactions with a non-affiliate. There
can be no assurance the rates charged reflect those that would have been
agreed upon following an arm's length negotiation.
PAGE F-25
The following table presents a summary of Chandler USA's operating
segments for the years ended December 31:
PROPERTY
AND INTERSEGMENT REPORTED
CASUALTY AGENCY ELIMINATIONS BALANCES
--------------------------------------------------------
(In thousands)
2005
Revenues from external customers .......................... $ 66,268 $ 43 $ - $ 66,311
Intersegment revenues ..................................... 1,963 8 (1,971) -
Interest income, net ...................................... 3,468 - - 3,468
Interest expense .......................................... 2,535 - - 2,535
Segment profit (loss) before income taxes (1) ............. 4,902 1,981 - 6,883
Segment assets ............................................ 244,907 2,394 (2,242) 245,059
Depreciation and amortization ............................. 1,486 - - 1,486
2006
Revenues from external customers .......................... $ 65,888 $ 133 $ - $ 66,021
Intersegment revenues ..................................... - 3,150 (3,150) -
Interest income, net ...................................... 10,572 21 - 10,593
Interest expense .......................................... 2,668 22 - 2,690
Segment profit (loss) before income taxes (1) ............. 1,819 3,242 - 5,061
Segment assets ............................................ 222,004 5,914 (5,146) 222,772
Depreciation and amortization ............................. 1,379 - - 1,379
2007
Revenues from external customers .......................... $ 66,753 $ 1,348 $ - $ 68,101
Intersegment revenues ..................................... 99 3,737 (3,836) -
Interest income, net ...................................... 41 328 - 369
Interest expense .......................................... 2,686 17 - 2,703
Segment profit (loss) before income taxes (1) ............. (2,463) 1,714 - (749)
Segment assets ............................................ 232,482 7,772 (5,887) 234,367
Depreciation and amortization ............................. 1,431 - - 1,431
- ---------------------------------------------------
<FN>
(1) Includes net realized investment gains.
The following table shows the detail of intersegment eliminations
for segment assets shown in the previous table:
2005 2006 2007
-------- -------- --------
(In thousands)
Segment asset eliminations
Investment in subsidiaries ............................. $ 1 $ 1 $ 1
Elimination of intersegment receivables ................ 2,241 5,145 5,886
-------- -------- --------
$ 2,242 $ 5,146 $ 5,887
======== ======== ========
PAGE F-26
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 2005 2006 2007
- ---------------------------------------------------------- ---------- ---------- ----------
(In thousands)
NET PREMIUMS EARNED
Standard lines ........................................... $ 54,979 $ 54,357 $ 62,342
Political subdivisions ................................... 6,690 5,253 3,436
Homeowners ............................................... 3,321 5,353 9
Surety bonds ............................................. 669 193 186
Other (1) ................................................ 401 548 212
---------- ---------- ----------
$ 66,060 $ 65,704 $ 66,185
========== ========== ==========
LOSSES AND LOSS ADJUSTMENT EXPENSES
Standard lines ........................................... $ 33,512 $ 40,212 $ 37,122
Political subdivisions ................................... 4,091 2,693 1,584
Homeowners ............................................... 1,306 2,515 (48)
Surety bonds ............................................. (1,704) (152) 2,082
Other (1) ................................................ 119 205 653
---------- ---------- ----------
$ 37,324 $ 45,473 $ 41,393
========== ========== ==========
- --------------------------
<FN>
(1) This category is comprised primarily of the run-off of discontinued programs and NAICO's
participation in various mandatory workers compensation pools.
NOTE 14. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
A summary of the unaudited quarterly operating results during 2006
and 2007 follows:
First Second Third Fourth Total
quarter quarter quarter quarter year
--------- --------- --------- --------- --------
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
2007
- -----------------------------------------------------
Net premiums earned ................................ $ 17,020 $ 15,870 $ 16,510 $ 16,785 $66,185
Investment income, net ............................. 1,372 1,108 1,166 (3,277) 369
Realized investment gains, net ..................... 35 26 34 119 214
Income (loss) before income taxes .................. 1,445 1,062 921 (4,177) (749)
Net income (loss) .................................. 914 668 514 (2,758) (662)
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. The accrual of prejudgment interest was decreased by
$4.5 million in the fourth quarter of 2007, based on a final judgment
entered by the court. See Note 10 for more information related to this
litigation.
* * * * * * *
PAGE F-27
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, 2006 and 2007, 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, 2007. 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.
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, 2006 and 2007, and the results of its
operations and its cash flows for each of the three years in the period
ended December 31, 2007 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.
We were not engaged to examine management's assertion about the
effectiveness of Chandler USA's internal control over financial
reporting as of December 31, 2007 included in the accompanying
Management's Report on Internal Control Over Financial Reporting and,
accordingly, we do not express an opinion thereon.
/s/ Tullius Taylor Sartain & Sartain LLP
TULLIUS TAYLOR SARTAIN & SARTAIN LLP
Tulsa, Oklahoma
March 27, 2008
PAGE F-28
SCHEDULE I
CHANDLER (U.S.A.), INC. AND SUBSIDIARIES
SUMMARY OF INVESTMENTS - OTHER
THAN INVESTMENTS IN RELATED PARTIES
AS OF DECEMBER 31, 2007
(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 ....... $ 38,723 $ 39,172 $ 39,172
Corporate obligations ......................... 18,703 18,506 18,506
Public utilities .............................. 4,287 4,231 4,231
Mortgage-backed securities .................... 1,187 1,148 1,148
------------ ---------- ---------------
62,900 63,057 63,057
EQUITY SECURITIES AVAILABLE FOR SALE:
Corporate stock ............................... - 141 141
Short-term investments ........................ 1,045 1,045 1,045
------------ ---------- ---------------
Total investments .......................... $ 63,945 $ 64,243 $ 64,243
============ ========== ===============
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)
BALANCE SHEETS
(In thousands except share amounts)
DECEMBER 31,
---------------------
2006 2007
---------- ----------
ASSETS
Property and equipment, net ........................................ 829 1,021
Amounts due from related parties ................................... 9,584 11,506
Other assets ....................................................... 3,678 2,561
Investment in subsidiaries, net .................................... 59,669 61,562
---------- ----------
Total assets ....................................................... $ 73,760 $ 76,650
========== ==========
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Accrued taxes and other payables .................................. $ 1,892 $ 2,169
Amounts due to subsidiaries ....................................... 1,305 3,278
Debentures ........................................................ 6,979 6,979
Junior subordinated debentures issued to affiliated trusts ........ 20,620 20,620
---------- ----------
Total liabilities .................................................. 30,796 33,046
---------- ----------
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 ............................................... (16,517) (17,179)
Accumulated other comprehensive income (loss):
Unrealized gain (loss) on investments held by subsidiary and available
for sale, net of deferred income taxes ........................... (1,105) 197
---------- ----------
Total shareholder's equity ......................................... 42,964 43,604
---------- ----------
Total liabilities and shareholder's equity. ........................ $ 73,760 $ 76,650
========== ==========
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 OPERATIONS
(In thousands)
YEAR ENDED DECEMBER 31,
----------------------------------
2005 2006 2007
---------- ---------- ----------
Revenues
Investment income, net ................................. $ 3 $ 4 $ 8
Interest income, net from related parties .............. 670 792 941
Other income ........................................... 908 1,334 1,020
---------- ---------- ----------
Total revenues ....................................... 1,581 2,130 1,969
---------- ---------- ----------
Operating costs and expenses
General and administrative expenses .................... 2,749 3,116 3,587
Interest expense ....................................... 2,519 2,649 2,665
---------- ---------- ----------
Total operating costs and expenses ................... 5,268 5,765 6,252
---------- ---------- ----------
Loss before income tax benefit ........................... (3,687) (3,635) (4,283)
Federal income tax benefit ............................... 1,198 1,606 1,430
---------- ---------- ----------
Net loss before equity in net
income of subsidiaries ................................. (2,489) (2,029) (2,853)
Equity in net income of subsidiaries ..................... 6,922 5,425 2,191
---------- ---------- ----------
Net income (loss) ........................................ $ 4,433 $ 3,396 $ (662)
========== ========== ==========
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-31
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,
----------------------------------
2005 2006 2007
---------- ---------- ----------
Operating activities
Net income (loss) ......................................... $ 4,433 $ 3,396 $ (662)
Add (deduct):
Adjustments to reconcile net income (loss) to cash
provided by (applied to) operating activities:
Net income of subsidiaries not distributed to parent ..... (6,922) (5,425) (2,191)
Net (gain) loss on sale of property and equipment ........ (7) 8 (6)
Amortization and depreciation ............................ 210 218 243
Net change in non-cash balances relating to
operating activities:
Premiums receivable ..................................... 7 - -
Amounts due from subsidiaries ........................... 1,128 148 -
Other assets ............................................ (121) 809 1,059
Accrued taxes and other payables ........................ (234) (162) 277
Amounts due to subsidiaries ............................. - 1,306 1,973
---------- ---------- ----------
Cash provided by (applied to) operating activities ....... (1,506) 298 693
---------- ---------- ----------
Investing activities
Cost of property and equipment purchased .................. (130) (145) (420)
Proceeds from sale of property and equipment .............. 67 45 49
---------- ---------- ----------
Cash applied to investing activities ..................... (63) (100) (371)
---------- ---------- ----------
Financing activities
Shareholder dividend from subsidiaries .................... - - 1,600
Payments and loans from related parties ................... 2,513 1,747 2,164
Payments and loans to related parties ..................... (982) (1,971) (4,086)
---------- ---------- ----------
Cash provided by (applied to) financing activities ....... 1,531 (224) (322)
---------- ---------- ----------
Decrease in cash ........................................... (38) (26) -
Cash at beginning of year .................................. 64 26 -
---------- ---------- ----------
Cash at end of year ........................................ $ 26 $ - $ -
========== ========== ===========
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-32
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, 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
=========== ========= ======== ========== ========= ========= ========== =========== ========= ========
DECEMBER 31, 2007
Property and casualty ... $ 1,118 $ 100,590 $ 46,389 $ 7,947 $ 66,185 $ 369 $ 41,393 $ 12,547 $ 15,493 $ 64,432
=========== ========= ======== ========== ========= ========= ========== =========== ========= ========
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-33
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, 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%
============ ============ ============ ============ ============
Year ended December 31, 2007
Property and casualty ........ $ 85,836 $ (35,649) $ 14,245 $ 64,432 22.11%
============ ============ ============ ============ ============
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-34
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:
2005 ........................... $ 119 $ 176 $ (72) $ 223
================ ================ ================ ===============
2006 ........................... $ 223 $ 73 $ (126) $ 170
================ ================ ================ ===============
2007 ........................... $ 170 $ 19 $ (55) $ 134
================ ================ ================ ===============
Allowance for non-collection of reinsurance
recoverables on paid and unpaid losses:
2005 ........................... $ 3,272 $ 108 $ (3,206) $ 174
================ ================ ================ ===============
2006 ........................... $ 174 $ 97 $ (141) $ 130
================ ================ ================ ===============
2007 ........................... $ 130 $ 356 $ (247) $ 239
================ ================ ================ ===============
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-35
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, 2005
Property-casualty ................... $ - $ 41,470
=============== =================
Year ended December 31, 2006
Property-casualty ................... $ - $ 43,941
=============== =================
Year ended December 31, 2007
Property-casualty ................... $ - $ 37,608
=============== =================
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-36
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.