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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
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SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2008
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
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SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from to
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COMMISSION FILE NUMBER: 1-15135
CHANDLER (U.S.A.), INC.
(Exact name of registrant as specified in its charter)
OKLAHOMA 73-1325906
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1010 MANVEL AVENUE, CHANDLER, OKLAHOMA 74834
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (405) 258-0804
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. YES X NO
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Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, 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)
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Smaller reporting company
--
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). YES NO X
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The number of common shares, $1.00 par value, of the registrant
outstanding on October 31, 2008 was 2,484, which are owned by Chandler
Insurance Company, Ltd.
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Page i
CHANDLER (U.S.A.), INC.
INDEX
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PART I - FINANCIAL INFORMATION
- ------------------------------
ITEM 1. FINANCIAL STATEMENTS:
- ------------------------------
Consolidated Balance Sheets as of September 30, 2008 (unaudited)
and December 31, 2007 ..................................................1
Consolidated Statements of Operations for the three months
ended September 30, 2008 and 2007 (unaudited) .........................2
Consolidated Statements of Operations for the nine months
ended September 30, 2008 and 2007 (unaudited) .........................3
Consolidated Statements of Comprehensive Income for the three
months ended September 30, 2008 and 2007 (unaudited) ..................4
Consolidated Statements of Comprehensive Income for the nine
months ended September 30, 2008 and 2007 (unaudited) ..................5
Consolidated Statements of Cash Flows for the nine months
ended September 30, 2008 and 2007 (unaudited) .........................6
Notes to Interim Consolidated Financial Statements (unaudited) ...........7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- ------------------------------------------------------------------------
RESULTS OF OPERATIONS ...........................................12
---------------------
ITEM 4T. CONTROLS AND PROCEDURES .........................................18
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PART II - OTHER INFORMATION
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Item 1. Legal Proceedings ............................................18
Item 1A. Risk Factors .................................................18
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds ..18
Item 3. Defaults Upon Senior Securities ..............................18
Item 4. Submission of Matters to a Vote of Security Holders ..........18
Item 5. Other Information ............................................18
Item 6. Exhibits .....................................................18
Signatures ...............................................................19
PAGE 1
CHANDLER (U.S.A.), INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands except share amounts)
September 30, December 31,
2008 2007
------------- --------------
(Unaudited)
ASSETS
Investments
Fixed maturities available for sale, at fair value
Restricted (amortized cost $37,222 and $32,416 in 2008 and 2007, respectively) ......... $ 37,173 $ 32,670
Unrestricted (amortized cost $36,917 and $30,484 in 2008 and 2007, respectively) ....... 36,390 30,387
Equity securities at fair value (cost $0 in 2008 and 2007) .............................. 76 141
Short-term investments (amortized cost $3,309 and $1,045 in 2008
and 2007, respectively) ................................................................ 3,300 1,045
------------- --------------
Total investments ...................................................................... 76,939 64,243
Cash and cash equivalents ($359 and $146 restricted in 2008 and 2007, respectively) ...... 19,793 32,956
Accrued investment income ................................................................ 920 874
Premiums receivable, less allowance for non-collection of $123 and $134 at
2008 and 2007, respectively ............................................................. 27,618 28,128
Reinsurance recoverable on paid losses ................................................... 2,524 1,100
Reinsurance recoverable on paid losses from related parties .............................. 687 -
Reinsurance recoverable on unpaid losses, less allowance for
non-collection of $243 and $239 at 2008 and 2007, respectively .......................... 35,242 36,036
Reinsurance recoverable on unpaid losses from related parties ............................ 19,570 18,688
Prepaid reinsurance premiums ............................................................. 3,044 3,105
Prepaid reinsurance premiums to related parties .......................................... 12,380 12,928
Deferred policy acquisition costs ........................................................ 1,142 1,118
Property and equipment, net .............................................................. 8,033 8,255
Amounts due from related parties ......................................................... 12,226 11,506
State insurance licenses, net ............................................................ 3,745 3,745
Other assets ............................................................................. 11,757 11,685
------------- --------------
Total assets ............................................................................. $ 235,620 $ 234,367
============= ==============
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Unpaid losses and loss adjustment expenses .............................................. $ 103,803 $ 100,590
Unearned premiums ....................................................................... 44,494 46,389
Policyholder deposits ................................................................... 8,662 7,947
Accrued taxes and other payables ........................................................ 5,017 5,777
Premiums payable ........................................................................ 2,071 2,263
Premiums payable to related parties ..................................................... - 198
Senior debentures ....................................................................... 6,979 6,979
Junior subordinated debentures issued to affiliated trusts .............................. 20,620 20,620
------------- --------------
Total liabilities ...................................................................... 191,646 190,763
============= ==============
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 ..................................................................... (16,276) (17,179)
Accumulated other comprehensive income (loss):
Unrealized gain (loss) on investments available for sale, net of deferred income taxes .. (336) 197
------------- --------------
Total shareholder's equity ............................................................. 43,974 43,604
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Total liabilities and shareholder's equity ............................................... $ 235,620 $ 234,367
============= ==============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 2
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Amounts in thousands)
Three months ended September 30,
---------------------------------
2008 2007
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Premiums and other revenues
Direct premiums written and assumed .......................... $ 24,160 $ 21,894
Reinsurance premiums ceded ................................... (2,441) (2,701)
Reinsurance premiums ceded to related parties ................ (6,533) (5,782)
------------ ------------
Net premiums written and assumed ........................... 15,186 13,411
Decrease in unearned premiums ................................ 505 3,099
------------ ------------
Net premiums earned ........................................ 15,691 16,510
Investment income, net ......................................... 828 918
Interest income, net from related parties ...................... 159 248
Realized investment gains, net ................................. 91 34
Other income ................................................... 731 369
------------ ------------
Total premiums and other revenues ............................ 17,500 18,079
------------ ------------
Operating costs and expenses
Losses and loss adjustment expenses, net of amounts
ceded to related parties of $3,665 and $4,407 in
2008 and 2007, respectively ................................ 11,352 10,230
Policy acquisition costs, net of ceding commissions
received from related parties of $2,484 and $2,200 in
2008 and 2007, respectively ................................ 3,097 3,197
General and administrative expenses .......................... 3,161 3,056
Interest expense ............................................. 628 675
------------ ------------
Total operating costs and expenses ......................... 18,238 17,158
------------ ------------
Income (loss) before income taxes .............................. (738) 921
Federal income tax benefit (provision) ......................... 175 (407)
------------ ------------
Net income (loss) ............................................ $ (563) $ 514
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 3
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Amounts in thousands)
Nine months ended September 30,
--------------------------------
2008 2007
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Premiums and other revenues
Direct premiums written and assumed ....................... $ 74,554 $ 73,347
Reinsurance premiums ceded ................................ (7,260) (5,014)
Reinsurance premiums ceded to related parties ............. (20,136) (20,701)
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Net premiums written and assumed ........................ 47,158 47,632
Decrease in unearned premiums ............................. 1,286 1,768
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Net premiums earned ..................................... 48,444 49,400
Investment income, net ...................................... 2,565 2,938
Interest income, net from related parties ................... 505 708
Realized investment gains, net .............................. 95 95
Other income ................................................ 1,559 1,364
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Total premiums and other revenues ......................... 53,168 54,505
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Operating costs and expenses
Losses and loss adjustment expenses, net of amounts
ceded to related parties of $11,296 and $12,433 in
2008 and 2007, respectively ............................. 30,668 30,263
Policy acquisition costs, net of ceding commissions
received from related parties of $7,656 and $7,874 in
2008 and 2007, respectively ............................. 9,464 9,479
General and administrative expenses ....................... 9,440 9,305
Interest expense .......................................... 1,907 2,030
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Total operating costs and expenses ...................... 51,479 51,077
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Income before income taxes .................................. 1,689 3,428
Federal income tax provision ................................ (786) (1,332)
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Net income ................................................ $ 903 $ 2,096
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See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 4
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Amounts in thousands)
Three months ended September 30,
--------------------------------
2008 2007
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Net income (loss)............................................. $ (563) $ 514
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Other comprehensive income (loss), before income tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period .. (401) 1,369
Less: Reclassification adjustment for gains included in
net income ............................................. (91) (34)
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Other comprehensive income (loss), before income tax ......... (492) 1,335
Income tax benefit (expense) related to items of other
comprehensive income (loss) ................................ 167 (454)
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Other comprehensive income (loss), net of income tax ......... (325) 881
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Comprehensive income (loss) .................................. $ (888) $ 1,395
============= ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 5
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Amounts in thousands)
Nine months ended September 30,
--------------------------------
2008 2007
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Net income ................................................... $ 903 $ 2,096
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Other comprehensive income (loss), before income tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period .. (712) 1,077
Less: Reclassification adjustment for gains included in
net income ............................................. (95) (95)
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Other comprehensive income (loss), before income tax ......... (807) 982
Income tax benefit (expense) related to items of other
comprehensive income (loss) ................................ 274 (334)
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Other comprehensive income (loss), net of income tax ......... (533) 648
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Comprehensive income ......................................... $ 370 $ 2,744
============= ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 6
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Amounts in thousands)
Nine months ended September 30,
-------------------------------
2008 2007
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OPERATING ACTIVITIES
Net income .................................................................. $ 903 $ 2,096
Add (deduct):
Adjustments to reconcile net income to cash provided by operating activities:
Realized investment gains, net .......................................... (95) (95)
Net gains on sale of property and equipment ............................. - (6)
Amortization and depreciation ........................................... 1,151 1,065
Provision for non-collection of premiums ................................ 15 41
Provision for non-collection of reinsurance recoverables ................ 155 126
Net change in non-cash balances relating to operating activities:
Accrued investment income ............................................. (46) (289)
Premiums receivable ................................................... 495 3,940
Reinsurance recoverable on paid losses ................................ (1,575) (106)
Reinsurance recoverable on paid losses from related parties ........... (687) -
Reinsurance recoverable on unpaid losses .............................. 790 (790)
Reinsurance recoverable on unpaid losses from related parties ......... (882) (1,754)
Prepaid reinsurance premiums .......................................... 61 4,267
Prepaid reinsurance premiums to related parties ....................... 548 585
Deferred policy acquisition costs ..................................... (24) (602)
Other assets .......................................................... 159 1,490
Unpaid losses and loss adjustment expenses ............................ 3,213 3,375
Unearned premiums ..................................................... (1,895) (6,619)
Policyholder deposits ................................................. 715 (55)
Accrued taxes and other payables ...................................... (760) 402
Premiums payable ...................................................... (192) 571
Premiums payable to related parties ................................... (198) (259)
------------ ------------
Cash provided by operating activities ................................... 1,851 7,383
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INVESTING ACTIVITIES
Short-term investments:
Purchases ............................................................... (3,594) -
Maturities .............................................................. 1,330 -
Unrestricted fixed maturities available for sale:
Purchases ............................................................... (34,192) (13,965)
Sales ................................................................... 6,417 5,016
Maturities .............................................................. 16,182 5,286
Equity securities available for sale:
Purchases ............................................................... (266) (5,811)
Sales ................................................................... 270 6,925
Cost of property and equipment purchased .................................. (570) (661)
Proceeds from sale of property and equipment .............................. 129 50
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Cash applied to investing activities .................................... (14,294) (3,160)
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FINANCING ACTIVITIES
Payments and loans from related parties ................................... 2,146 1,730
Payments and loans to related parties ..................................... (2,866) (3,854)
Payments on bank loan ..................................................... - (252)
------------ ------------
Cash applied to financing activities .................................... (720) (2,376)
------------ ------------
Increase (decrease) in cash and cash equivalents during the period .......... (13,163) 1,847
Cash and cash equivalents at beginning of period ............................ 32,956 21,403
------------ ------------
Cash and cash equivalents at end of period .................................. $ 19,793 $ 23,250
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 7
CHANDLER (U.S.A.), INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
(Unaudited)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Chandler
(U.S.A.), Inc. ("Chandler USA") have been prepared in accordance with
generally accepted accounting principles for interim financial information
and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. They
do not include all information and footnotes required by generally accepted
accounting principles for complete financial statements. However, except as
disclosed herein, there have been no material changes in the information
included in Chandler USA's Annual Report on Form 10-K for the year ended
December 31, 2007. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation
have been included. The results of operations for the three and nine month
periods ended September 30, 2008 are not necessarily indicative of the
results that may be expected for the year.
The consolidated financial statements include the accounts of Chandler
USA and all wholly owned subsidiaries that meet consolidation requirements
including National American Insurance Company ("NAICO") and Chandler
Insurance Managers, Inc. ("CIMI").
NOTE 2. 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.
The following table presents a summary of Chandler USA's operating segments
for the three and nine month periods ended September 30, 2008 and 2007:
Property
and
casualty Intersegment Reported
insurance Agency eliminations balances
------------ ------------ ------------ ------------
(In thousands)
THREE MONTHS ENDED SEPTEMBER 30, 2008
Revenues from external customers (1) ........... $ 15,848 $ 574 $ - $ 16,422
Intersegment revenues .......................... 21 805 (826) -
Segment profit (loss) before income taxes (2) .. (1,282) 544 - (738)
THREE MONTHS ENDED SEPTEMBER 30, 2007
Revenues from external customers (1) ........... $ 16,620 $ 259 $ - $ 16,879
Intersegment revenues .......................... 7 1,170 (1,177) -
Segment profit (loss) before income taxes (2) .. 299 622 - 921
NINE MONTHS ENDED SEPTEMBER 30, 2008
Revenues from external customers (1) ........... $ 48,839 $ 1,164 $ - $ 50,003
Intersegment revenues .......................... 44 2,525 (2,569) -
Segment profit (loss) before income taxes (2) .. 477 1,212 - 1,689
Segment assets ................................. 233,081 9,871 (7,332) 235,620
NINE MONTHS ENDED SEPTEMBER 30, 2007
Revenues from external customers (1) ........... $ 49,638 $ 1,126 $ - $ 50,764
Intersegment revenues .......................... 58 3,294 (3,352) -
Segment profit (loss) before income taxes (2) .. 1,430 1,998 - 3,428
Segment assets ................................. 220,742 7,622 (5,685) 222,679
<FN>
- -----------------------------------------------------
(1) Consists of net premiums earned and other income.
(2) Includes net realized investment gains.
PAGE 8
Net premiums earned and losses and loss adjustment expenses within the
property and casualty insurance segment can be identified to Chandler USA
designated insurance programs. Chandler USA's chief operating decision
makers review net premiums earned and losses and loss adjustment expenses
in assessing the performance of an insurance program. In addition, Chandler
USA's chief operating decision makers consider many other factors such as the
lines of business offered within an insurance program and the states in which
the insurance programs are offered. Certain discrete financial information
is not readily available by insurance program, including assets, interest
income, and investment gains or losses, allocated to each insurance program.
Chandler USA does not consider its insurance programs to be reportable
segments, however, the following supplemental information pertaining to each
insurance program's net premiums earned and losses and loss adjustment
expenses is presented for the property and casualty insurance segment.
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- ------------------------------
2008 2007 2008 2007
------------ ------------ ------------ ------------
(In thousands)
INSURANCE PROGRAM
---------------------------------------
NET PREMIUMS EARNED
Standard lines ........................ $ 14,943 $ 15,639 $ 46,169 $ 46,367
Political subdivisions ................ 694 787 2,092 2,722
Surety bonds .......................... 17 32 70 162
Other (1) ............................. 37 52 113 149
------------ ------------ ------------ ------------
$ 15,691 $ 16,510 $ 48,444 $ 49,400
============ ============ ============ ============
LOSSES AND LOSS ADJUSTMENT EXPENSES
---------------------------------------
Standard lines ........................ $ 10,703 $ 9,862 $ 28,881 $ 28,275
Political subdivisions ................ 626 248 1,481 1,538
Surety bonds .......................... (93) 177 82 87
Other (1) ............................. 116 (57) 224 363
------------ ------------ ------------ ------------
$ 11,352 $ 10,230 $ 30,668 $ 30,263
============ ============ ============ ============
<FN>
- ------------------------------------------------------
(1) This program is comprised primarily of the run-off of other discontinued
programs and NAICO's participation in various mandatory workers compensation
pools.
NOTE 3. COMMITMENTS AND CONTINGENCIES
During March 2001, Chandler USA entered into a $3.8 million sale and
leaseback transaction for certain owned equipment for three years. During
March 2004, the lease was extended for three years and 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 which was 6.0% at
September 30, 2008. 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 Chandler Capital Trust I
and Chandler Capital Trust II (the "Capital Trusts"). The Capital Trusts are
wholly owned non-consolidated subsidiaries of Chandler USA that have a total
of $20 million of trust preferred securities outstanding. Chandler USA
guarantees payment of distributions and the redemption price of the trust
preferred securities until the securities are redeemed in full.
PAGE 9
NOTE 4. LITIGATION
In October 1999, NAICO provided surety bonds for Gulsby Engineering,
Inc. ("Gulsby") in connection with contracts between Gulf Liquids New River
Project, LLC ("Gulf Liquids") and Gulsby for the construction of two gas
processing plants in Louisiana. During 2001, Gulsby became unable to pay
various vendors resulting in payments to vendors by NAICO totaling
$20,182,499. In August 2001, NAICO filed suit in federal court in Louisiana
alleging that Gulf Liquids had breached its obligations under the bonds by
materially altering certain contracts and that, as a result, NAICO was
exonerated on the bonds and should recover the amounts paid to vendors. In
the fall of 2001, Gulsby and Bay Limited, another contractor with whom
Gulsby had entered into a joint venture for the construction of other gas
processing plants for Gulf Liquids, filed lawsuits relating to those plants
in Houston, Texas. Gulf Liquids filed original actions and counterclaims.
NAICO intervened in the Texas lawsuits and, in addition, sued Williams
Energy Marketing and Trading (which later became Williams Power Company,
Inc.) ("Williams") alleging fraud, breach of contract, tortious
interference with contractual relations, conspiracy and alter ego. These
claims were asserted against both Gulf Liquids and Williams. Gulf Liquids
asserted counterclaims alleging breach of contract against NAICO and
requesting contractual and statutory damages ranging from $40 million to
$80 million. The cases were consolidated for trial in the 215th Judicial
District Court in Harris County, Texas.
The trial in the Harris County cases began in late April 2006, and
concluded August 1, 2006. The jury found in favor of NAICO 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. Gulf Liquids has
appealed the judgment entered in favor of Gulsby and the denial of its
claims against NAICO and Gulsby. NAICO has appealed the trial court's
denial of its claims against Gulf Liquids and Williams and seeks entry of
judgment upon the jury verdicts for the amounts the jury found should be
awarded to NAICO. Gulsby has also appealed the trial court's final
judgment, contending that judgment should be entered in its favor against
Gulf Liquids and Williams in accordance with the jury verdicts.
PAGE 10
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 5. 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 September 2006, the FASB issued Statement of Financial Accounting
Standards ("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 has
adopted SFAS No. 157 as of January 1, 2008. The adoption of SFAS No. 157
did not have a material impact on its consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option
for Financial Assets and Financial Liabilities-Including an amendment of
FASB Statement No. 115." SFAS No. 159 permits companies to choose to
measure many financial instruments and certain other items at fair value at
specified election dates. Upon adoption, an entity shall report unrealized
gains and losses on items for which the fair value option has been elected
in earnings at each subsequent reporting date. Most of the provisions
apply only to entities that elect the fair value option. However, the
amendment to SFAS No. 115, "Accounting for Certain Investments in Debt and
Equity Securities," applies to all entities with available for sale and
trading securities. Chandler USA has adopted SFAS No. 159 as of January
1, 2008, but did not elect the fair value option prescribed under SFAS
No. 159 for any financial assets or liabilities that were not otherwise
required to be measured at fair value. The adoption of SFAS No. 159 did
not have a material impact 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. Chandler USA has adopted EITF No. 06-10
effective January 1, 2008. The adoption of EITF No. 06-10 did not have a
material impact on its consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161, "Disclosures about
Derivative Instruments and Hedging Activities - an amendment of FASB
Statement No. 133." SFAS No. 161 changes the disclosure requirements for
derivative instruments and hedging activities. Entities are required to
provide enhanced disclosures about (a) how and why an entity uses
derivative instruments, (b) how derivative instruments and related hedged
items are accounted for under SFAS No. 133 and its related interpretations,
and (c) how derivative instruments and related hedged items affect an
entity's financial position, financial performance and cash flows. The
guidance in SFAS No. 161 is effective for financial statements issued for
fiscal years and interim periods beginning after November 15, 2008, with
early application encouraged. Chandler USA is currently evaluating the
impact that SFAS No. 161 will have, if any, on its consolidated financial
statements.
In May 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally
Accepted Accounting Principles." SFAS No. 162 identifies the sources of
accounting principles and the framework for selecting the principles to be
used in the preparation of financial statements of nongovernmental entities
that are presented in conformity with generally accepted accounting
principles in the United States. It will be effective 60 days following
the SEC's approval of the Public Company Accounting Oversight Board
amendments to AU Section 411, "The Meaning of Present Fairly in Conformity
With Generally Accepted Accounting Principles." Chandler USA does not
expect this statement to have a material impact on its consolidated
financial statements.
PAGE 11
In May 2008, the FASB issued SFAS No. 163, "Accounting for Financial
Guarantee Insurance Contracts - an interpretation of FASB Statement No. 60."
SFAS No. 163 requires that an insurance enterprise recognize a claim
liability prior to an event of default when there is evidence that credit
deterioration has occurred in an insured financial obligation. It also
clarifies how Statement 60 applies to financial guarantee insurance
contracts, including the recognition and measurement to be used to account
for premium revenue and claim liabilities, and requires expanded disclosures
about financial guarantee insurance contracts. It is effective for
financial statements issued for fiscal years beginning after December 15,
2008, except for some disclosures about the insurance enterprise's
risk-management activities. SFAS No. 163 requires that disclosures about
the risk-management activities of the insurance enterprise be effective for
the first period beginning after issuance. Except for those disclosures,
earlier application is not permitted. Chandler USA does not issue financial
guarantee insurance contracts. The adoption of SFAS No. 163 will not have
any impact on its consolidated financial statements.
NOTE 6. FAIR VALUE MEASUREMENTS
Effective January 1, 2008, Chandler USA adopted SFAS No. 157 which
establishes a framework for measuring fair value and requires specific
disclosures regarding assets and liabilities that are measured at fair
value. SFAS No. 157 defines fair value as the price that would be received
to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date. SFAS No. 157 ranks
the quality and reliability of the information used to determine fair
values into three broad categories, with the highest priority given to
Level 1 inputs and the lowest priority to Level 3 inputs. These levels are
defined by SFAS No. 157 as follows:
Level 1 - Quoted prices (unadjusted) in active markets for identical
assets or liabilities that the reporting entity has the ability to
access at the measurement date.
Level 2 - Observable inputs other than quoted prices included within
Level 1 for the asset or liability, either directly or indirectly.
If an asset or liability has a specified term, a Level 2 input must
be observable for substantially the full term of the asset or liability.
Level 3 - Unobservable inputs for the asset or liability.
The following table presents information about Chandler USA's assets
measured at fair value on a recurring basis as of September 30, 2008, and
indicates the fair value hierarchy of the valuation techniques utilized to
determine such values. Substantially all of the prices of fixed maturities,
equity securities and short-term investments that are valued as level 1 or
level 2 in the fair value hierarchy are received from independent pricing
services utilized by our investment custodians. No liabilities were
measured at fair value at September 30, 2008.
FAIR VALUE MEASUREMENTS AT SEPTEMBER 30, 2008
--------------------------------------------------------
Quoted prices Significant
in active other Significant
markets for observable unobservable
identical assets inputs inputs Total
Description (Level 1) (Level 2) (Level 3) fair value
- --------------------------------------- ---------------- ------------ ------------- ------------
(In thousands)
Fixed maturities available for sale .. $ - $ 73,563 $ - $ 73,563
Equity securities available for sale.. - - 76 76
Short-term investments ............... - 3,300 - 3,300
---------------- ------------ ------------- -----------
TOTAL ............................... $ - $ 76,863 $ 76 $ 76,939
================ ============ ============= ===========
PAGE 12
At September 30, 2008, Chandler USA's equity securities which were
measured at fair value using Level 3 inputs consisted of common stock
received in connection with an unaffiliated entity's conversion to a
for-profit corporation. The fair value of this stock was based upon an
analytically determined valuation from an independent rating organization.
The following table presents additional information about assets measured
at fair value using Level 3 inputs for the three and nine month periods
ended September 30, 2008.
Three months Nine months
Fair value measurements using significant ended ended
unobservable inputs (Level 3) September 30, 2008 September 30, 2008
------------------------------------------------- ------------------ ------------------
(In thousands)
Beginning balance .............................. $ 76 $ 141
Total realized and unrealized gains (losses):
Included in earnings ....................... - -
Included in other comprehensive income ..... - (65)
Purchases, issuances and settlements ......... - -
Transfers in and/or out of Level 3 ........... - -
------------------ ------------------
Ending balance ................................. $ 76 $ 76
================== ==================
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
Some of the statements made in this Form 10-Q report, as well as
statements made by Chandler (U.S.A.), Inc. ("Chandler USA") in periodic
press releases and oral statements made by Chandler USA's officials
constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Such forward-looking statements
involve known and unknown risks, uncertainties and other factors that may
cause the actual results, performance or achievements of Chandler USA to
be materially different from any future results, performance or
achievements expressed or implied by the forward-looking statements. Such
factors include, among other things, (i) general economic and business
conditions; (ii) interest rate changes; (iii) competition and regulatory
environment in which Chandler USA and its subsidiaries operate, including
the ability to implement price increases; (iv) claims frequency; (v) claims
severity; (vi) catastrophic events of unanticipated frequency or severity;
(vii) the number of new and renewal policy applications submitted to
National American Insurance Company ("NAICO") by its agents; (viii) the
ability of NAICO to obtain adequate reinsurance in amounts and at rates
that will not adversely affect its competitive position; (ix) the ability
of NAICO to collect reinsurance recoverables; (x) the ability of NAICO to
maintain favorable insurance company ratings; and (xi) various other
factors including ongoing litigation matters.
PAGE 13
RESULTS OF OPERATIONS
PREMIUMS EARNED
The following table sets forth premiums earned on a gross basis (before
reductions for premiums ceded to reinsurers) and on a net basis (after such
reductions) for each insurance program for the three and nine month periods
ended September 30, 2008 and 2007:
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
--------------------------- ---------------------------
THREE MONTHS ENDED SEPTEMBER 30, 2008 2007 2008 2007
---------------------------------- ------------ ------------ ------------ ------------
(In thousands)
Standard lines .................. $ 23,787 $ 25,270 $ 14,943 $ 15,639
Political subdivisions .......... 1,058 1,203 694 787
Surety bonds .................... 25 46 17 32
Other ........................... 37 51 37 52
------------ ------------ ------------ ------------
TOTAL ........................... $ 24,907 $ 26,570 $ 15,691 $ 16,510
============ ============ ============ ============
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
--------------------------- ---------------------------
NINE MONTHS ENDED SEPTEMBER 30, 2008 2007 2008 2007
---------------------------------- ------------ ------------ ------------ ------------
(In thousands)
Standard lines .................. $ 73,046 $ 75,085 $ 46,169 $ 46,367
Political subdivisions .......... 3,190 3,987 2,092 2,722
Surety bonds .................... 100 231 70 162
Other ........................... 113 664 113 149
------------ ------------ ------------ ------------
TOTAL ........................... $ 76,449 $ 79,967 $ 48,444 $ 49,400
============ ============ ============ ============
Gross premiums earned decreased $1.7 million or 6% and $3.5 million or
4% in the third quarter and first nine months of 2008, respectively,
compared to the 2007 periods. The decreases were due primarily to a
decrease in automobile liability premiums of $2.5 million and $4.6 million
in the third quarter and first nine months of 2008, respectively, which was
due to a decrease in premiums from trucking accounts. The decreases were
partially offset by increases in workers compensation and other liability
premiums in these periods. Net premiums earned decreased $819,000 or 5%
and $956,000 or 2% for the third quarter and first nine months of 2008,
respectively.
Gross premiums earned in the standard lines program decreased $1.5
million or 6% and $2.0 million or 3% in the third quarter and first nine
months of 2008, respectively, compared to the 2007 periods. Workers
compensation premiums in this program increased $601,000 and $1.8 million
in the third quarter and first nine months of 2008, respectively, and other
liability premiums increased $353,000 and $1.3 million in these periods.
However, automobile liability premiums decreased $2.5 million and $4.2
million in these periods. Net premiums earned decreased $696,000 or 4%
and $198,000 or less than 1% in the third quarter and first nine months of
2008, respectively.
Gross premiums earned in the political subdivisions program decreased
$145,000 or 12% and $797,000 or 20% in the third quarter and first nine
months of 2008, respectively, compared to the 2007 periods. The decrease
in gross premiums earned is due primarily to increased competition related
to Oklahoma school districts. Net premiums earned in this program
decreased $93,000 or 12% and $630,000 or 23% in the third quarter and
first nine months of 2008, respectively.
Gross and net premiums earned in the surety bond program decreased from
the 2007 periods. NAICO no longer actively markets its surety bond program.
Other premiums 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.
PAGE 14
NET INVESTMENT INCOME AND NET REALIZED INVESTMENT GAINS
At September 30, 2008, 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 20% 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 $317,000 in the
first quarter of 2007 for the accrual of prejudgment interest on a
favorable jury verdict in civil litigation in 2006 regarding certain
surety bond claims. See "LITIGATION" and Note 4 of Notes to Interim
Consolidated Financial Statements.
Net investment income, excluding interest income from related parties
and the prejudgment interest accrual, decreased $90,000 or 10% and
decreased $56,000 or 2% in the third quarter and first nine months of
2008, respectively. An increase in cash and invested assets was offset
by lower interest rates during the 2008 periods. Cash and invested
assets were $96.7 million at September 30, 2008 compared to $94.8 million
at September 30, 2007. Net interest income from related parties decreased
$89,000 or 36% and $203,000 or 29% in the third quarter and first nine
months of 2008, respectively, due primarily to lower interest rates.
Net realized investment gains were $91,000 and $95,000 during the
third quarter and first nine months of 2008, respectively. Net realized
investment gains were $34,000 and $95,000 during the third quarter and
first nine months of 2007, respectively.
OTHER INCOME
Other income was $731,000 and $1.6 million in the third quarter and
first nine months of 2008, respectively, compared to $369,000 and $1.4
million in the third quarter and first nine months of 2007. The increase
in the third quarter of 2008 was due primarily to an increase in commission
income related to business produced by CIMI for insurance companies other
than NAICO.
LOSSES AND LOSS ADJUSTMENT EXPENSES
Chandler USA estimates losses and loss adjustment expenses based on
historical experience and payment and reporting patterns for the type of
risk involved. These estimates are based on data available at the time
of the estimate and are periodically reviewed by independent professional
actuaries. Although such estimates are management's best estimates of
the expected values, the ultimate liability for unpaid claims may vary
from these values.
The percentage of losses and loss adjustment expenses to net premiums
earned ("loss ratio") was 72.3% and 63.3% for the third quarter and first
nine months of 2008, compared to 62.0% and 61.3% in the corresponding 2007
periods. The increase in the 2008 loss ratios was due primarily to an
increase in losses incurred related to prior accident years in the workers
compensation portion of the standard lines program. In the third
quarter of 2008, losses and loss adjustment expenses incurred related to
prior accident years were $1.7 million and increased the loss ratio by
10.9 percentage points. In the first nine months of 2008, losses and loss
adjustment expenses incurred related to prior accident years were $1.2
million which increased the loss ratio by 2.5 percentage points. In the
third quarter of 2007, losses and loss adjustment expenses incurred related
to prior accident years were $14,000. In the first nine months of 2007,
loss development was redundant by $287,000.
Weather-related losses from wind and hail totaled $18,000 and $322,000
in the third quarter and first nine months of 2008 and increased the
respective loss ratios by 0.1 and 0.7 percentage points. Weather-related
losses totaled $35,000 and $109,000 in the third quarter and first nine
months of 2007, and increased the respective 2007 loss ratios by 0.2
percentage points in both periods.
PAGE 15
POLICY ACQUISITION COSTS
Policy acquisition costs consist of costs associated with the
acquisition of new and renewal business and generally include direct costs
such as premium taxes, commissions to agents and ceding companies and
premium-related assessments and indirect costs such as salaries and
expenses of personnel who perform and support underwriting activities.
NAICO also receives ceding commissions from the reinsurers who assume
premiums from NAICO under certain reinsurance contracts and the ceding
commissions are accounted for as a reduction of policy acquisition costs.
Direct policy acquisition costs and ceding commissions are deferred and
amortized over the terms of the policies. When the sum of anticipated
losses, loss adjustment expenses and unamortized policy acquisition costs
exceeds the related unearned premiums, including anticipated investment
income, a provision for the indicated deficiency is recorded.
The following table sets forth Chandler USA's policy acquisition costs
for each of the three and nine month periods ended September 30, 2008 and 2007:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
2008 2007 2008 2007
---------- ---------- ---------- ----------
(In thousands)
Commissions expense .......................... $ 3,306 $ 3,139 $ 10,584 $ 10,418
Other premium related assessments ............ 293 245 840 766
Premium taxes ................................ 471 490 1,471 1,642
Excise taxes ................................. 65 58 201 207
Other expense ................................ 111 187 416 640
---------- ---------- ---------- ----------
Total direct expenses ........................ 4,246 4,119 13,512 13,673
Indirect underwriting expenses ............... 1,649 1,500 4,832 4,420
Commissions received from reinsurers ......... (2,855) (2,608) (8,856) (8,012)
Adjustment for deferred acquisition costs .... 57 186 (24) (602)
---------- ---------- ---------- ----------
Net policy acquisition costs ................. $ 3,097 $ 3,197 $ 9,464 $ 9,479
========== ========== ========== ==========
Total direct expenses as a percentage of direct written and assumed
premiums were 17.8% and 18.1% for the third quarter and first nine months
of 2008, compared to 18.8% and 18.6% in the corresponding year ago periods.
Commissions expense as a percentage of gross written and assumed premiums
was 13.7% and 14.2% in the third quarter and the first nine months of 2008
compared to 14.3% and 14.2% in the corresponding 2007 periods.
Indirect underwriting expenses were 6.8% and 6.5% of total direct
written and assumed premiums in the third quarter and first nine months of
2008, respectively, compared to 6.9% and 6.0% in the corresponding 2007
periods. Indirect expenses include general overhead and administrative
costs associated with the acquisition of new and renewal business, some of
which is relatively fixed in nature, thus, the percentage of such expenses
to direct written and assumed premiums will vary depending on Chandler
USA's overall premium volume. Commissions received from reinsurers as a
percent of ceded reinsurance premiums were 31.8% and 32.3% in the third
quarter and first nine months of 2008, respectively, compared to 30.7% and
31.2% in the corresponding 2007 periods.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were 12.3% and 12.1% of gross
premiums earned and other income in the third quarter and first nine
months of 2008, respectively, compared to 11.3% and 11.4% for the
corresponding 2007 periods. 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
PAGE 16
INTEREST EXPENSE
Interest expense decreased $47,000 and $123,000 in the third quarter
and first nine months of 2008, respectively, compared to the 2007 periods.
Substantially all of Chandler USA's interest expense is related to its
outstanding senior debentures and junior subordinated debentures. The
decrease in the 2008 periods was due primarily to lower interest rates
during 2008, as a portion of Chandler USA's junior subordinated debentures
were issued with a floating interest rate.
LIQUIDITY AND CAPITAL RESOURCES
In the first nine months of 2008, Chandler USA provided $1.9 million
in cash from operations. Cash provided by operations included an increase
in unpaid losses and loss adjustment expenses of $3.2 million. This was
partially offset by a decrease in unearned premiums of $1.9 million and
an increase in reinsurance recoverables on paid losses of $2.3 million. In
the first nine months of 2007, Chandler USA provided $7.4 million in cash
from operations.
NAICO is required to deposit cash and securities with regulatory
agencies in which it is licensed as a condition of conducting operations
in the state. In addition, NAICO has deposited cash and securities into
a trust account as collateral for a reinsurance agreement in which NAICO
is the assuming reinsurer. At September 30, 2008, the total amount of
cash and securities restricted as a result of these arrangements was $37.5
million which was an increase of $4.7 million from December 31, 2007.
This increase was due to an increase in the amount of reinsurance that
NAICO assumed during 2008.
At September 30, 2008, Chandler USA's parent company, Chandler
Insurance Company, Ltd., owed approximately $12.2 million to Chandler USA
versus $11.5 million at December 31, 2007 under an Intercompany Credit
Agreement (the "Credit Agreement") covering intercompany loans between the
parties. The Credit Agreement requires interest to be paid at the prime
interest rate published in the Wall Street Journal each month, and balances
owed by either party are payable at any time upon demand.
During March 2001, Chandler USA entered into a $3.8 million sale and
leaseback transaction for certain owned equipment for three years. During
March 2004, the lease was extended for three years and 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 which was 6.0%
at September 30, 2008. 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 is a holding company receiving cash principally through
borrowings, subsidiary dividends and other payments, subject to various
regulatory restrictions. The capacity of insurance companies to write
insurance is based on maintaining liquidity and capital resources sufficient
to pay claims and expenses as they become due. The primary sources of
liquidity for Chandler USA's subsidiaries are funds generated from insurance
premiums, investment income, capital contributions from Chandler USA and
proceeds from sales and maturities of portfolio investments. The principal
expenditures are payment of losses and loss adjustment expenses, insurance
operating expenses and commissions.
A significant portion of Chandler USA's consolidated assets represents
assets of NAICO that may not be immediately transferable to Chandler USA in
the form of shareholder dividends, loans, advances or other payments.
Statutes and regulations governing NAICO and other insurance companies
domiciled in Oklahoma regulate the payment of shareholder dividends and
other payments by NAICO to Chandler USA. Under applicable Oklahoma
statutes and regulations, NAICO is permitted to pay shareholder dividends
only out of statutory earned surplus. To the extent NAICO has statutory
earned surplus, NAICO may pay shareholder dividends only to the extent that
such dividends are not defined as extraordinary dividends or distributions.
If the dividends are, under applicable statutes and regulations,
extraordinary dividends or distributions, regulatory approval must be
obtained. Under the applicable Oklahoma statute, and subject to the
availability of statutory earned surplus, the maximum shareholder dividend
that may be declared (or cash or property distribution that may be made)
by NAICO in any one calendar year without regulatory approval is the
greater of (i) NAICO's statutory net income, excluding realized capital
gains, for the preceding calendar year; or (ii) 10% of NAICO's statutory
policyholders' surplus as of the preceding calendar year end, not to exceed
NAICO's statutory earned surplus.
PAGE 17
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 cash
shareholder dividends of $1.0 million to Chandler USA in June 2008 and
$1,050,000 in September 2008. NAICO paid a cash shareholder dividend of
$1.6 million to Chandler USA in May 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 previously. Management's expectation is that
Chandler Insurance or other subsidiaries will be able to meet these
obligations in the future. It is possible that dividends from NAICO may
be necessary to service Chandler USA's debt obligations. To the extent
that the restrictions discussed previously limit NAICO's ability to pay
shareholder dividends or other payments to Chandler USA, Chandler USA's
ability to satisfy the debt obligations may also be limited.
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 4 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. In addition, unpaid losses
and loss adjustment expenses decreased $22.7 million, reinsurance recoverable
on unpaid losses and loss adjustment expenses decreased $16.8 million, and
reinsurance recoverable on paid losses and loss adjustment expenses
decreased $1.2 million. NAICO also recorded $6.6 million of interest income
for its estimate of prejudgment interest through December 31, 2006 and
recorded an additional $317,000 of prejudgment interest during the first
quarter of 2007 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. Gulf
Liquids has appealed the judgment entered in favor of Gulsby and the denial
of its claims against NAICO and Gulsby. NAICO has appealed the trial
court's denial of its claims against Gulf Liquids and Williams and seeks
entry of judgment upon the jury verdicts for the amounts the jury found
should be awarded to NAICO. Gulsby has also appealed the trial court's
final judgment, contending that judgment should be entered in its favor
against Gulf Liquids and Williams in accordance with the jury verdicts.
PAGE 18
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.
ITEM 4T. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
As of the end of the period covered by this report and pursuant to
Rule 13a-15 of the Securities Exchange Act of 1934 (the "Exchange Act"),
Chandler USA's management, including the Chief Executive Officer and Chief
Financial Officer, conducted an evaluation of the effectiveness and design
of Chandler USA's disclosure controls and procedures (as that term is
defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act). Based upon
that evaluation, Chandler USA's Chief Executive Officer and Chief Financial
Officer concluded, as of the end of the period covered by this report, that
Chandler USA's disclosure controls and procedures were effective in
recording, processing, summarizing and reporting information required to
be disclosed by Chandler USA, within the time periods specified in the
Securities and Exchange Commission's rules and forms.
CHANGES IN INTERNAL CONTROLS
In addition and as of the end of the period covered by this report,
there have been no changes in internal control over financial reporting
(as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) during
the quarter to which this report relates that have materially affected or
are reasonably likely to materially affect, the internal control over
financial reporting.
PART II. OTHER INFORMATION
-----------------
Item 1. LEGAL PROCEEDINGS
-----------------
Chandler USA and its subsidiaries are not parties to any material
litigation other than as is routinely encountered in their
respective business activities. While the outcome of these
matters cannot be predicted with certainty, Chandler USA does not
expect these matters to have a material adverse effect on its
financial condition, results of operations or cash flows. See
Note 4 of Notes to Interim Consolidated Financial Statements for
a discussion of a favorable jury verdict in civil litigation
regarding certain surety bond claims.
Item 1A. RISK FACTORS
------------
There have been no material changes from risk factors previously
disclosed in our Annual Report on Form 10-K for the year ended
December 31, 2007.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
-----------------------------------------------------------
None.
Item 3. DEFAULTS UPON SENIOR SECURITIES
-------------------------------
None.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
None.
Item 5. OTHER INFORMATION
-----------------
None.
Item 6. EXHIBITS
--------
31.1 Rule 13a-14(a)/15d-14(a) Certifications.
32.1 Section 1350 Certifications.
PAGE 19
SIGNATURES
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Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 11, 2008 CHANDLER (U.S.A.), INC.
By: /s/ W. Brent LaGere
--------------------------------------
W. Brent LaGere
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
By: /s/ Mark C. Hart
--------------------------------------
Mark C. Hart
Senior Vice President - Finance, Chief
Financial Officer and Treasurer
(Principal Accounting Officer)