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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, 2008
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 NYSE ALTERNEXT US LLC
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, 2008, the last business day of the registrant's most
recently completed second fiscal quarter: None.
The number of common shares, $1.00 par value, of the registrant outstanding
on February 28, 2009 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 200 at December 31, 2008, 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 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.
CIMI and Praetorian have agreed to terminate this arrangement effective June
29, 2009. At the present time, CIMI expects that a similar arrangement with
another insurance company will be completed prior to the termination of the
current arrangement.
PAGE 2
POLITICAL SUBDIVISIONS PROGRAM
Under the political subdivisions program, NAICO writes insurance policies
primarily for school districts in Oklahoma. As of December 31, 2008, NAICO
insured 97 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 that were
previously written by NAICO are being written by Praetorian through an
arrangement between Praetorian and CIMI. CIMI and Praetorian have agreed
to terminate this arrangement effective June 29, 2009. At the present
time, CIMI expects that a similar arrangement with another insurance company
will be completed prior to the termination of the current arrangement.
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 2006, 2007 and 2008. 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 2006 2007 2008 2006 2007 2008
- ---------------------------------------- -------- -------- -------- -------- -------- --------
(In thousands)
Standard lines ......................... $ 91,153 $100,844 $ 96,587 $ 54,357 $ 62,342 $ 61,047
Political subdivisions ................. 14,337 5,084 4,191 5,253 3,436 2,747
Homeowners ............................. 8,542 501 - 5,353 9 -
Surety bonds ........................... 278 266 119 193 186 83
Other (1) .............................. 550 214 150 548 212 150
-------- -------- -------- -------- -------- --------
TOTAL .................................. $114,860 $106,909 $101,047 $ 65,704 $ 66,185 $ 64,027
======== ======== ======== ======== ======== ========
- -------------------------------------------
<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,
--------------------------------------------
2004 2005 2006 2007 2008
-------- -------- -------- -------- --------
Automobile liability ........ 28% 29% 32% 40% 34%
Workers compensation ........ 27% 25% 23% 27% 32%
Other liability ............. 28% 27% 25% 23% 25%
Automobile physical damage .. 9% 9% 8% 9% 9%
Property .................... 4% 8% 11% 1% -%
Inland marine ............... 1% 1% 1% -% -%
Surety ...................... 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 an arrangement between Praetorian and CIMI. Because of
these changes, NAICO's net premiums earned for property and inland marine
business in 2007 and 2008 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 and for a number
of unaffiliated insurance companies. 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 authorized to secure qualified insurance agents for
NAICO and assists 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. CIMI and Praetorian have agreed
to terminate this arrangement effective June 29, 2009. At the present time,
CIMI expects that a similar arrangement with another insurance company will
be completed prior to the termination of the current arrangement. 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, 2009.
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.
Effective July 1, 2004, NAICO's net retention under the workers compensation
reinsurance program was 70% 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, 2005, NAICO's net retention under the casualty reinsurance
program was 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, 2006, NAICO's net retention for
umbrella liability losses was 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 2006 property reinsurance program, 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.
Effective January 1, 2005, NAICO retains 70% of each loss per occurrence
under the automobile physical damage reinsurance program. 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, 2008.
CEDED REINSURANCE
NET PREMIUMS FOR A.M. BEST
REINSURANCE THE YEAR ENDED COMPANY
NAME OF REINSURER RECOVERABLE (1) DECEMBER 31, 2008 RATING
- ---------------------------------------------------------- --------------- ------------------ -----------
(Dollars in thousands)
Chandler Insurance ....................................... $ 32,102 $ 26,596 (2)
Swiss Reinsurance America Corporation (3)................. 15,999 338 A
Westport Insurance Corporation (3)........................ 13,314 - A
Transatlantic Reinsurance Company ........................ 2,640 1,987 A
Markel Insurance Company ................................. 2,553 1,772 A
--------------- ------------------
Top five reinsurers ................................. $ 66,608 $ 30,693
=============== ==================
All reinsurers ...................................... $ 67,899 $ 36,072
=============== ==================
Percentage of total represented by top five reinsurers ... 98% 85%
- -------------------------------------------------------------
<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, 2008.
(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, 2008, Chandler Insurance had cash and investments, including accrued
interest, with a fair value of $32.1 million deposited in a trust account for the benefit of NAICO.
(3) Westport Insurance Corporation and Swiss Reinsurance America Corporation are subsidiaries of Swiss
Reinsurance Company.
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 $97,000, $356,000 and $166,000 during 2006, 2007 and 2008,
respectively, in adjustments to ceded losses and loss adjustment expenses for
amounts deemed uncollectible.
PAGE 6
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 (net of agency fee income) to net premiums earned
("underwriting expense ratio").
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,
------------------------------------------------
2004 2005 2006 2007 2008
-------- -------- -------- -------- --------
(Dollars in thousands)
Automobile liability:
Net premiums earned ......................... $ 17,742 $ 19,126 $ 21,122 $ 26,469 $ 21,537
Loss ratio .................................. 61% 82% 99% 74% 70%
Workers compensation:
Net premiums earned ......................... $ 17,371 $ 16,475 $ 15,361 $ 17,861 $ 20,681
Loss ratio .................................. 85% 53% 63% 62% 76%
Other liability:
Net premiums earned ......................... $ 18,044 $ 18,052 $ 16,628 $ 15,137 $ 16,301
Loss ratio .................................. 121% 48% 57% 32% 38%
Automobile physical damage:
Net premiums earned ......................... $ 5,933 $ 5,807 $ 5,008 $ 6,096 $ 5,492
Loss ratio .................................. 43% 56% 63% 55% 75%
Property:
Net premiums earned ......................... $ 2,611 $ 5,594 $ 7,082 $ 279 $ 1
Loss ratio .................................. 47% 41% 41% 64% (750)%
Surety:
Net premiums earned ......................... $ 1,993 $ 669 $ 194 $ 186 $ 83
Loss ratio .................................. 134% (255)% (459)% 1,119% (52)%
Inland marine:
Net premiums earned ......................... $ 348 $ 337 $ 309 $ 157 $ (68)
Loss ratio .................................. 29% 162% 30% 19% (5)%
Total:
Net premiums earned ......................... $ 64,042 $ 66,060 $ 65,704 $ 66,185 $ 64,027
Loss ratio .................................. 84% 57% 69% 63% 64%
Underwriting expense ratio (1) .............. 37% 35% 37% 36% 37%
-------- -------- -------- -------- --------
Combined ratio (1) .......................... 121% 92% 106% 99% 101%
======== ======== ======== ======== ========
- -------------------------------------------------
<FN>
(1) During 2008, Chandler USA revised its method of calculating its underwriting expense ratio to
underwriting expenses (net of agency fee income) divided by net premiums earned. Prior period
ratios have been restated to conform to the current period's presentation.
PAGE 7
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.
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 $11.1 million and $10.9 million at December 31, 2007 and
2008. Included in these recoverable amounts were net recoverables of
$10.1 million in 2007 and 2008, 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,
------------------------------------------------------
2004 2005 2006 2007 2008
---------- ---------- ---------- ---------- ----------
(In thousands)
Net balance at beginning of year ................. $ 29,343 $ 44,695 $ 40,549 $ 42,081 $ 45,866
---------- ---------- ---------- ---------- ----------
Net losses and loss adjustment expenses incurred
related to:
Current year ................................. 27,436 30,985 41,644 40,194 38,869
Prior years .................................. 26,345 6,339 3,829 1,199 2,071
---------- ---------- ---------- ---------- ----------
Total ...................................... 53,781 37,324 45,473 41,393 40,940
---------- ---------- ---------- ---------- ----------
Net paid losses and loss adjustment expenses
related to:
Current year ................................. (10,222) (11,171) (12,403) (12,494) (11,856)
Prior years .................................. (28,207) (30,299) (31,538) (25,114) (25,882)
---------- ---------- ---------- ---------- ----------
Total ...................................... (38,429) (41,470) (43,941) (37,608) (37,738)
---------- ---------- ---------- ---------- ----------
Net balance at end of year ....................... $ 44,695 $ 40,549 $ 42,081 $ 45,866 $ 49,068
========== ========== ========== ========== ==========
NAICO experienced a significant amount of incurred losses related to prior
accident years during the 2004-2006 calendar years. The adverse loss
development was generally the result of ongoing analysis of loss development
trends for both liability and workers compensation lines of business, and
included 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 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 loss development included approximately $409,000
for provisions for potentially uncollectible reinsurance and deductibles.
Reserves for unpaid losses and loss adjustment expenses, net of related
reinsurance recoverables, were $44.7 million at December 31, 2004 compared to
$29.3 million at December 31, 2003, an increase of $15.4 million or 52%.
During 2005, NAICO experienced adverse loss development totaling $6.3
million primarily in the standard lines and political subdivisions programs.
A portion of the adverse development was offset by favorable development of
$1.8 million in the surety bond program, primarily in accident years 1994
and 2001 that resulted from the estimated recoveries discussed previously.
The adverse development was due primarily to an increase in losses in the
workers compensation, other liability and automobile liability lines of
business in the 2000, 2002 and 2003 accident years. The adverse loss
development included approximately $108,000 for provisions for potentially
uncollectible reinsurance.
During 2006, NAICO experienced adverse loss development totaling $3.8
million primarily in the standard lines program. A portion of the adverse
development was offset by favorable development of $1.0 million in the
surety bond program, primarily in the 2001 accident year, that resulted from
the estimated recoveries discussed previously. The adverse development was
due primarily to an increase in losses in the automobile liability line of
business in the 2005 accident year and in the workers compensation line of
business in the 1997 and 1999 accident years. The adverse loss development
included approximately $97,000 for provisions for potentially uncollectible
reinsurance.
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 9
During 2008, NAICO experienced adverse loss development totaling $2.1
million primarily in the workers compensation line of business in the
standard lines program. A portion of the adverse loss development was
offset by favorable development in the automobile liability line of
business in this program. The adverse loss development included
approximately $166,000 for provisions for potentially uncollectible
reinsurance.
The following table represents the development of net balance sheet reserves
for 1999 through 2008. 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 2002 for
claims that occurred in 1999 will be included in the cumulative deficiency
amount for years 1999, 2000, 2001 and 2002. 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.
DEVELOPMENT OF RESERVES
AS OF DECEMBER 31,
------------------------------------------------------------------------------------------------------
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
--------- ---------- ---------- ---------- --------- --------- --------- --------- --------- ---------
(In thousands)
Net reserve for unpaid losses and
loss adjustment expenses .. $ 51,378 $ 46,707 $ 32,812 $ 33,191 $ 29,343 $ 44,695 $ 40,549 $ 42,081 $ 45,866 $ 49,068
Net paid (cumulative) as of
One year later ........... 36,009 43,799 37,050 30,422 28,207 30,299 31,537 25,111 25,882
Two years later .......... 58,979 66,141 60,560 51,375 50,158 50,183 46,348 39,931
Three years later ........ 72,052 81,635 77,413 68,643 63,900 58,263 54,405
Four years later ......... 80,860 91,403 89,349 79,591 69,099 63,164
Five years later ......... 86,257 97,700 98,060 83,845 72,937
Six years later .......... 88,859 99,506 101,213 86,328
Seven years later ........ 89,346 101,257 103,109
Eight years later ........ 90,708 102,461
Nine years later ......... 91,764
Net liability re-estimated as of
One year later ............ 56,357 59,376 48,596 44,283 55,688 51,034 44,378 43,280 47,937
Two years later ........... 67,469 74,325 67,903 70,058 61,369 50,989 50,909 45,071
Three years later ......... 77,842 86,377 89,608 73,962 61,216 57,175 53,585
Four years later .......... 83,860 100,408 91,520 74,805 66,153 59,725
Five years later .......... 91,704 102,370 91,700 79,781 68,663
Six years later ........... 92,084 104,227 96,161 81,643
Seven years later ......... 93,873 106,396 98,123
Eight years later ......... 95,812 107,610
Nine years later .......... 96,941
Net cumulative (deficiency)
redundancy ................ $(45,563) $ (60,903) $ (65,311) $ (48,452) $(39,320) $(15,030) $(13,036) $ (2,990) $ (2,071) $ -
Supplemental gross data:
Gross liability ........... $ 98,460 $ 100,173 $ 84,756 $ 92,606 $ 87,768 $108,233 $109,541 $ 83,253 $100,590 $101,459
Reinsurance recoverable ... 47,082 53,466 51,944 59,415 58,425 63,538 68,992 41,172 54,724 52,391
--------- ---------- ---------- ---------- --------- --------- --------- --------- --------- ---------
Net liability-end of year.. $ 51,378 $ 46,707 $ 32,812 $ 33,191 $ 29,343 $ 44,695 $ 40,549 $ 42,081 $ 45,866 $ 49,068
========= ========== ========== ========== ========= ========= ========= ========= ========= =========
Gross re-estimated
liability - latest ....... $193,962 $ 270,871 $ 296,765 $ 245,572 $181,034 $154,041 $132,434 $110,983 $109,680
Re-estimated recoverable -
latest ................... 97,021 163,261 198,642 163,929 112,371 94,316 78,849 65,912 61,743
--------- ---------- ---------- ---------- --------- --------- --------- --------- ---------
Net re-estimated
liability - latest ....... $ 96,941 $ 107,610 $ 98,123 $ 81,643 $ 68,663 $ 59,725 $ 53,585 $ 45,071 $ 47,937
========= ========== ========== ========== ========= ========= ========= ========= =========
Gross cumulative (deficiency)
redundancy ................ $(95,502) $(170,698) $(212,009) $(152,966) $(93,266) $(45,808) $(22,893) $(27,730) $ (9,090)
========= ========== ========== ========== ========= ========= ========= ========= =========
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, 2008, all of the investments of NAICO were in
fixed-maturity investments, 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. At December 31, 2008, all but $3.2 million or 4% of total
fixed maturity investments were rated AA or better by Moody's Investor
Service, Inc. or Standard & Poor's. The remaining fixed maturities were
rated A by Moody's Investor Service, Inc., and Baa1 or A2 by Standard &
Poor's. 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,
2008, 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). The interest rate was 8.92% at December 31, 2008. 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). The interest rate was 8.92% at December
31, 2008. 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. Under FIN 46R, Chandler USA
reports the $20.6 million of junior subordinated debentures that were issued
to the capital trusts on its consolidated balance sheet.
EMPLOYEES AND ADMINISTRATION
At December 31, 2008, Chandler USA and its subsidiaries had 184 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 improved. The pricing
environment during 2005 through 2008 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 during
2006, 2007 and 2008. 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, 2008, NAICO had statutory earned surplus of $13.4
million. Applying the Oklahoma statutory limits described above, the
maximum shareholder dividend NAICO may pay in 2009 without the approval of
the Oklahoma Department of Insurance is $5.1 million. NAICO paid
shareholder dividends to Chandler USA totaling $1.6 million and $2.1 million
in 2007 and 2008, respectively.
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 5.8:1 and 6.5:1 at December 31, 2007 and 2008, 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 did not have any 2008 ratios that were outside of the "usual values".
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 2008 Annual Report on Form 10-K, should be considered carefully.
IF OUR ACTUAL LOSSES EXCEED OUR LOSS RESERVES, OUR FINANCIAL RESULTS WOULD
BE ADVERSELY AFFECTED.
We maintain reserves for unpaid losses and loss adjustment expenses which
are estimates of the expense of investigation and settlement of all reported
and incurred but not reported losses under our previously issued insurance
policies and/or reinsurance contracts. These reserves do not represent an
exact measurement of liability, but are estimates based upon historical data
and anticipated future events. The process of estimating loss reserves is
complex and imprecise. We periodically review the reserve estimates and the
methods used to arrive at such reserve estimates, and we also retain
independent professional actuaries who review such reserve estimates and
methods. Any changes that result from these reviews are reflected in
current operating results.
If our estimates are incorrect and our reserves are inadequate, we are
required to increase our reserves. An increase in reserves results in an
increase in losses and a reduction in our net income for the period in which
the deficiency is identified. Accordingly, an increase in reserves could
have a material adverse effect on our results of operations, liquidity and
financial condition.
CATASTROPHIC EVENTS AND ACTS OF TERRORISM CAN HAVE A SIGNIFICANT IMPACT ON
OUR RESULTS OF OPERATIONS, LIQUIDITY AND FINANCIAL CONDITION.
We are subject to claims arising out of catastrophes that may have a
significant effect on our results of operations, liquidity and financial
condition. Catastrophes can be caused by various events, including
tornadoes, windstorms, hail, fires, severe winter weather, earthquakes,
power outages and explosions, and may include man-made events such as
terrorist attacks. The frequency and severity of these catastrophes are
inherently unpredictable. The extent of losses from a catastrophe is a
function of both the total amount of insured exposure in the area affected
by the event and the severity of the event.
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.
PAGE 16
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 improved. The pricing environment during
2005 through 2008 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 during 2006, 2007 and 2008. 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.
The severe downturn in the public debt and equity markets could result
in a significant reduction in the fair value of our investment portfolio
and our investment income. Depending on market conditions going forward,
we could incur significant realized and unrealized losses in future periods,
which could have an adverse impact on our results of operations, financial
condition and financial strength ratings. We believe that we have mitigated
the impact of these conditions by maintaining a high-quality investment
portfolio. At December 31, 2008, all but $3.2 million or 4% of our fixed
maturity investments were rated AA or better by Moody's Investor Service,
Inc. or Standard & Poor's. The remaining fixed maturities were rated A by
Moody's Investor Service, Inc. and Baa1 or A2 by Standard & Poor's.
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,
which could result from an increase in interest rates or other market
conditions, 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 2006, 2007 and 2008, 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 2008, approximately 75% 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 lower, 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. 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 11 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, 2008.
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, 2008 have been audited by
HoganTaylor LLP, independent auditors, whose independent auditors' report
expresses an unqualified opinion. Tullius Taylor Sartain & Sartain LLP
merged with Hogan & Slovacek, P.C. to form HoganTaylor LLP effective January
7, 2009. 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,
-------------------------------------------------
2004 2005 2006 2007 2008
--------- --------- --------- --------- ---------
(Dollars in thousands)
OPERATING DATA
Revenues
Direct premiums written and assumed .................... $121,651 $120,344 $113,043 $100,081 $ 98,384
========= ========= ========= ========= =========
Net premiums earned .................................... $ 64,042 $ 66,060 $ 65,704 $ 66,185 $ 64,027
Investment income, net (1).............................. 3,186 2,798 9,801 (572) 3,347
Interest income, net from related parties .............. 491 670 792 941 647
Realized investment gains, net ......................... 652 383 745 214 95
Other income ........................................... 640 251 317 1,916 2,069
--------- --------- --------- --------- ---------
Total revenues ........................................... 69,011 70,162 77,359 68,684 70,185
--------- --------- --------- --------- ---------
Operating expenses
Losses and loss adjustment expenses .................... 53,781 37,324 45,473 41,393 40,940
Policy acquisition costs ............................... 11,039 10,671 11,666 12,547 12,348
General and administrative expenses .................... 12,380 12,749 12,469 12,790 13,124
Interest expense ....................................... 2,397 2,535 2,690 2,703 2,569
--------- --------- --------- --------- ---------
Total operating expenses ................................. 79,597 63,279 72,298 69,433 68,981
--------- --------- --------- --------- ---------
Income (loss) before income taxes ........................ (10,586) 6,883 5,061 (749) 1,204
Federal income tax benefit (provision) ................... 3,582 (2,450) (1,665) 87 (679)
--------- --------- --------- --------- ---------
Net income (loss) ........................................ $ (7,004) $ 4,433 $ 3,396 $ (662) $ 525
========= ========= ========= ========= =========
Combined loss and underwriting expense ratio (2) ......... 121% 92% 106% 99% 101%
BALANCE SHEET DATA
Cash and investments ..................................... $ 86,913 $ 86,316 $ 89,703 $ 97,199 $103,673
Amounts due from related parties ......................... 10,891 9,360 9,584 11,506 11,869
Total assets ............................................. 237,297 245,059 222,772 234,367 234,647
Unpaid losses and loss adjustment expenses ............... 108,233 109,541 83,253 100,590 101,459
Debentures ............................................... 6,979 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 ........................................ 201,105 205,373 179,808 190,763 189,282
Shareholder's equity ..................................... 36,192 39,686 42,964 43,604 45,365
- ------------------------------------------------------------
<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) During 2008, Chandler USA revised its method of calculating its underwriting expense ratio to underwriting expenses
(net of agency fee income) divided by net premiums earned. Prior period ratios have been restated to conform to
the current period's presentation.
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 an arrangement between Praetorian and CIMI.
CIMI and Praetorian have agreed to terminate this arrangement effective June
29, 2009. At the present time, CIMI expects that a similar arrangement with
another insurance company will be completed prior to the termination of the
current arrangement. 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, 2008, Chandler USA had net income of
$525,000 compared to a net loss of $662,000 for 2007 and net income of $3.4
million for 2006. 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 11 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, 2008, NAICO's case
reserves and IBNR for each line of business are shown in the following table.
Gross reserves at December 31, 2008 Net reserves at December 31, 2008
----------------------------------- ---------------------------------
Case Total Case Total
reserves IBNR reserves reserves IBNR reserves
----------- ----------- ----------- ---------- ---------- -----------
(In thousands) (In thousands)
Automobile liability ......... $ 25,117 $ 15,674 $ 40,791 $ 17,884 $ 9,977 $ 27,861
Workers compensation ......... 28,725 20,875 49,600 11,032 9,562 20,594
Other liability .............. 4,215 27,138 31,353 3,076 8,396 11,472
Automobile physical damage ... 597 - 597 421 - 421
Property ..................... 12 3 15 3 3 6
Surety ....................... (21,028) 130 (20,898) (11,286) - (11,286)
Accident and health .......... 1 - 1 - - -
Inland marine ................ - - - - - -
----------- ----------- ----------- ---------- ---------- -----------
Total reserves .............. $ 37,639 $ 63,820 $ 101,459 $ 21,130 $ 27,938 $ 49,068
=========== =========== =========== ========== ========== ===========
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
line of business. 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, 2008.
Line of Insurance Low High Recorded
------------------------------------------- --------- ---------- ----------
(In thousands)
Gross Reserves
--------------
Automobile liability .................... $ 31,004 $ 53,057 $ 39,808
Workers compensation .................... 35,787 62,269 43,107
Other liability ......................... 25,796 54,712 30,571
Automobile physical damage .............. 587 942 587
Surety bonds ............................ (20,899) (20,899) (20,899)
Involuntary workers compensation pools .. 5,370 5,370 5,370
Other ................................... 2,915 2,915 2,915
--------- ---------- ----------
Total .............................. $ 80,560 $ 158,366 $ 101,459
========= ========== ==========
Net Reserves
--------------
Automobile liability .................... $ 20,442 $ 35,620 $ 26,879
Workers compensation .................... 11,832 20,687 13,870
Other liability ......................... 8,333 16,617 10,690
Automobile physical damage .............. 411 658 411
Surety bonds ............................ (11,289) (11,289) (11,289)
Involuntary workers compensation pools .. 5,370 5,370 5,370
Other ................................... 3,137 3,137 3,137
--------- ---------- ----------
Total .............................. $ 38,236 $ 70,800 $ 49,068
========= ========== ==========
For the workers compensation net reserves, NAICO's actuaries selected an
average of the case incurred and cumulative paid projections for accident
years 1999 through 2004. Results of the cumulative paid projection were
relied upon for accident years 2005 and 2006, and the 2007 and 2008
accident year selections were based on judgmentally selected loss ratios.
Workers compensation gross reserve selections were made on the same basis
as the net reserves except that the 1999, 2002 and 2005 selections were
based on judgmentally selected IBNR amounts. For the automobile liability
net reserves, the actuaries relied on the mean of the results of all
methods examined for accident years prior to 2008. The 2008 accident year
selection was based on a judgmentally selected loss ratio. Automobile
liability gross reserves were made on the same basis except that the 1999
and 2002 selections were based on judgmentally selected IBNR amounts. For
the general liability net reserves, the actuaries relied on judgmentally
selected loss ratios for all accident years except for the 1999 and 2001
accident years, which were based on judgmentally selected IBNR amounts.
General liability gross reserves were based on judgmentally selected IBNR
amounts for the 1999 through 2002 accident years, on cumulative paid
projections for the 2003 through 2007 accident years, and on a judgmentally
selected loss ratio for the 2008 accident year. The loss settlement period
for automobile physical damage claims is relatively short, and the actuaries
used case incurred losses for their selection for all accident years.
Surety bond reserves are actually a net receivable due to anticipated
subrogation recoveries. Certain involuntary workers compensation pools
provided their own estimates and NAICO records these estimates plus an
accrual to account for the lag time in reporting to NAICO.
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 actuarial methods used in the 2008 loss reserve
analysis were similar to those used in the 2007 analysis. During 2008,
NAICO modified the way that the loss data was grouped for analysis
purposes so that the data could be analyzed by line of business rather
than by insurance program. Management believes that by doing so, the
analysis is enhanced since each line of business may produce different
loss development trend patterns.
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.
PAGE 24
NAICO does not ordinarily insure against environmental matters as that term
is commonly used. However, in some cases, regulatory filings made on behalf
of an insured can make NAICO directly liable to the regulatory authority for
property damage, which could include environmental pollution. In those
cases, NAICO ordinarily has recourse against the insured or the surety bond
principal for amounts paid. NAICO has insured certain trucking companies and
pest control operators who are required to provide proof of insurance which
in some cases assures payment for cleanup and restoration of damage
resulting from sudden and accidental release or discharge of contaminants or
other substances which may be classified as pollutants. NAICO also provides
surety bonds for construction contractors who use or have control of such
substances and for contractors who remove and dispose of asbestos as a part
of their contractual obligations.
NAICO also insures independent oil and gas producers who may purchase
coverage for the escape of oil, saltwater, or other substances which may
be harmful to persons or property, but may not generally be classified as
pollutants. NAICO maintains claims records which segregate this type of
risk for the purpose of evaluating environmental risk exposure. Based upon
the nature of such lines of business with NAICO's insureds, and current data
regarding the limited severity and infrequency of such matters, it appears
that potential environmental risks are not a significant portion of claim
reserves and therefore would not likely have a material adverse impact, if
any, on the financial condition of Chandler USA.
NAICO's statutory-based reserves (reserves calculated in accordance with
accounting practices prescribed or permitted by an insurer's domiciliary
state insurance regulatory authorities for purposes of financial reporting
to regulators) do not differ from its reserves reported on the basis of
GAAP. NAICO does not discount its reserves for unpaid losses and loss
adjustment expenses.
Management believes that its unpaid losses and related reinsurance
recoverables are fairly stated as of December 31, 2008. 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 a
re 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 was fully
utilized during 2008.
In addition, at December 31, 2008, Chandler USA had net operating
loss carryforwards available for Oklahoma state income taxes totaling
approximately $35.0 million which expire in the years 2009 through
2028. 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 $73.9 million, or 75%, of
NAICO's direct written and assumed premiums in 2008 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.
PAGE 25
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.
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 improved. The
pricing environment during 2005 through 2008 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
during 2006, 2007 and 2008. 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."
PAGE 26
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.
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,
--------------------------------
2006 2007 2008
---------- ---------- ----------
(Dollars in thousands)
INSURANCE PROGRAMS
- ----------------------------------------
STANDARD LINES
Net premiums earned .................. $ 54,357 $ 62,342 $ 61,047
Loss ratio ........................... 74.0% 59.5% 63.7%
POLITICAL SUBDIVISIONS
Net premiums earned .................. $ 5,253 $ 3,436 $ 2,747
Loss ratio ........................... 51.3% 46.1% 67.7%
HOMEOWNERS
Net premiums earned .................. $ 5,353 $ 9 $ -
Loss ratio ........................... 47.0% (560.0)% -%
SURETY BONDS
Net premiums earned .................. $ 193 $ 186 $ 83
Loss ratio ........................... (78.8)% 1,119.1% (51.9)%
OTHER (1)
Net premiums earned .................. $ 548 $ 212 $ 150
Loss ratio ........................... 37.5% 307.2% 127.8%
TOTAL
Net premiums earned .................. $ 65,704 $ 66,185 $ 64,027
Loss ratio ........................... 69.2% 62.5% 63.9%
- -------------------------
<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,
--------------------------------
2006 2007 2008
---------- ---------- ----------
(Dollars in thousands)
LINES OF INSURANCE
- ----------------------------------------
AUTOMOBILE LIABILITY
Net premiums earned .................. $ 21,122 $ 26,469 $ 21,537
Loss ratio ........................... 99.5% 73.7% 69.6%
WORKERS COMPENSATION
Net premiums earned .................. $ 15,361 $ 17,861 $ 20,681
Loss ratio ........................... 63.3% 62.2% 75.8%
OTHER LIABILITY
Net premiums earned .................. $ 16,628 $ 15,137 $ 16,301
Loss ratio ........................... 56.9% 32.4% 37.7%
AUTOMOBILE PHYSICAL DAMAGE
Net premiums earned .................. $ 5,008 $ 6,096 $ 5,492
Loss ratio ........................... 62.6% 55.0% 75.4%
PROPERTY
Net premiums earned .................. $ 7,082 $ 279 $ 1
Loss ratio ........................... 41.3% 63.9% (750.4)%
SURETY
Net premiums earned .................. $ 194 $ 186 $ 83
Loss ratio ........................... (459.4)% 1,119.1% (51.9)%
INLAND MARINE
Net premiums earned .................. $ 309 $ 157 $ (68)
Loss ratio ........................... 30.0% 18.9% (5.2)%
TOTAL
Net premiums earned .................. $ 65,704 $ 66,185 $ 64,027
Loss ratio ........................... 69.2% 62.5% 63.9%
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 2006 2007 2008 2006 2007 2008
- -------------------------------- -------- -------- --------- -------- -------- --------
(In thousands)
Standard lines ................. $ 91,153 $100,844 $ 96,587 $ 54,357 $ 62,342 $61,047
Political subdivisions ......... 14,337 5,084 4,191 5,253 3,436 2,747
Homeowners ..................... 8,542 501 - 5,353 9 -
Surety bonds ................... 278 266 119 193 186 83
Other .......................... 550 214 150 548 212 150
-------- -------- --------- -------- -------- --------
TOTAL .......................... $114,860 $106,909 $101,047 $ 65,704 $ 66,185 $64,027
======== ======== ========= ======== ======== ========
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
----------------------------- ----------------------------
LINES OF INSURANCE 2006 2007 2008 2006 2007 2008
- -------------------------------- -------- -------- --------- -------- -------- --------
(In thousands)
Automobile liability ........... $ 31,615 $ 39,298 $ 31,261 $ 21,122 $ 26,469 $21,537
Workers compensation ........... 23,562 28,337 31,967 15,361 17,861 20,681
Other liability ................ 31,744 28,995 29,732 16,628 15,137 16,301
Automobile physical damage ..... 7,720 9,021 8,065 5,008 6,096 5,492
Property ....................... 18,335 745 2 7,082 279 1
Surety ......................... 278 266 119 194 186 83
Inland marine .................. 1,606 247 (99) 309 157 (68)
-------- -------- --------- -------- -------- --------
TOTAL .......................... $114,860 $106,909 $101,047 $ 65,704 $ 66,185 $64,027
======== ======== ========= ======== ======== ========
Gross premiums earned decreased 7% and 5% in 2007 and 2008, respectively.
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. The
decrease in 2008 gross premiums earned was due primarily to a decrease in
automobile liability premiums in the standard lines program. Gross premiums
earned in Texas decreased 29% and 21% in 2007 and 2008, respectively, and
gross premiums earned in Oklahoma decreased 14% in 2007 and increased 6% in
2008.
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 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. CIMI and Praetorian
have agreed to terminate this arrangement effective June 29, 2009. At the
present time, CIMI expects that a similar arrangement with another
insurance company will be completed prior to the termination of the current
arrangement.
Net premiums earned increased 1% in 2007 and decreased 3% in 2008. 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. During 2008, net premiums earned increased for the workers
compensation and other liability lines of insurance, but decreased for
automobile liability due to the decrease in gross premiums earned.
PAGE 29
Gross premiums earned in the standard lines program increased 11% in 2007
and decreased 4% in 2008. Gross premiums earned for workers compensation
business in this program increased $5.1 million or 22% in 2007, and
increased $3.7 million or 13% in 2008. NAICO also increased premiums from
trucking accounts in 2006 and 2007. Gross premiums earned from trucking
accounts increased $12.0 million in 2007, but decreased $8.2 million in
2008. Net premiums earned in the standard lines program increased 15% in
2007 and decreased 2% in 2008. Net premiums earned from trucking accounts
increased $7.7 million in 2007 and decreased $4.6 million in 2008.
Gross premiums earned in the political subdivisions program decreased 65%
and 18% in 2007 and 2008, 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 35% and 20% in 2007 and 2008, respectively. The decrease
in net premiums earned in 2007 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 4% and 55% in
2007 and 2008, respectively. Net premiums earned decreased 4% and 55% in
2007 and 2008, 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, 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 $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 11 of Notes to Consolidated Financial
Statements.
Net investment income, excluding interest income from related parties
and the prejudgment interest, increased 13% in 2007 and decreased 6% in
2008. Interest income from related parties was $792,000, $941,000 and
$647,000 during 2006, 2007 and 2008, respectively. The increase in 2007
was due primarily to higher interest rates and to an increase in the
amount loaned to Chandler Insurance, while the decrease in 2008 was due
to lower interest rates. See Liquidity and Capital Resources.
Net realized investment gains were $745,000, $214,000 and $95,000 in
2006, 2007 and 2008, respectively.
The average net yield on the fixed maturity portfolio, including net
realized investment gains, was 3.6%, 4.0% and 3.4% in 2006, 2007 and
2008, respectively. The average net yield on the fixed maturity
portfolio, excluding net realized investment gains, was 3.6% for 2006,
3.8% for 2007 and 3.3% for 2008. 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, 2008
was approximately $12.0 million. The average yield on the fixed maturity
portfolio before deducting investment expenses was 4.0% in 2006, 4.2% in
2007 and 3.6% in 2008, excluding net realized capital gains.
OTHER INCOME
Other income was $317,000, $1,916,000 and $2,069,000 during 2006, 2007
and 2008, respectively. Approximately $1.1 million of 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 an arrangement effective January 1, 2007. Under this arrangement,
CIMI receives commission income for the business it produces for
Praetorian. The increase in 2008 was due to an increase in commission
income related to business produced by CIMI for insurance companies other
than NAICO.
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 69.2%, 62.5% and 63.9% in 2006, 2007 and 2008,
respectively. Weather-related losses (net of applicable reinsurance) from
wind and hail were $727,000, $109,000 and $344,000 in 2006, 2007 and 2008,
respectively, and increased the respective loss ratios by 1.1, 0.2 and 0.5
percentage points. Weather-related losses have decreased due in part to
the transfer of the property and inland marine lines of business in the
standard lines and political subdivisions programs to Praetorian in 2007.
NAICO experienced a significant amount of incurred losses related to prior
accident years during the 2006 calendar year. Incurred losses related to
prior accident years decreased $2.6 million or 69% in 2007 and increased
$872,000 or 73% in 2008. 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
--------------------------------
2006 2007 2008
---------- ---------- ----------
(In thousands)
Automobile liability ..................... $ 3,028 $ (691) $ (1,660)
Workers compensation ..................... 994 1,314 3,536
Other liability .......................... 590 (1,796) 216
Automobile physical damage ............... 261 65 1
Property ................................. (47) (173) 23
Surety ................................... (986) 2,074 (49)
Accident and health ...................... 4 394 -
Inland marine ............................ (15) 12 4
---------- ---------- ----------
$ 3,829 $ 1,199 $ 2,071
========== ========== ==========
In 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. During 2008, workers compensation losses developed
adversely by $3.5 million, but the automobile liability line of business
offset approximately $1.7 million of this. 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
2000 2000 2001 2002 2003 2004 2005 2006 2007 Total
-------- -------- --------- --------- -------- -------- -------- -------- -------- ---------
(In thousands)
Reserves at beginning of 2006 ... $ 3,000 $ 1,579 $ (2,444) $ 3,188 $ 5,896 $ 9,525 $19,805 $ - $ - $ 40,549
Development during 2006 ......... 1,789 68 (1,678) 663 (996) 108 3,875 - - 3,829
-------- -------- --------- --------- -------- -------- -------- -------- -------- ---------
Re-estimated reserves at
beginning of 2006 ............. $ 4,789 $ 1,647 $ (4,122) $ 3,851 $ 4,900 $ 9,633 $23,680 $ - $ - $ 44,378
======== ======== ========= ========= ======== ======== ======== ======== ======== =========
Reserves at beginning of 2007.... $ 4,267 $ 329 $(11,030) $ 1,610 $ 2,132 $ 3,492 $12,051 $29,230 $ - $ 42,081
Development during 2007 ......... 1,939 230 2,292 515 (39) 1,249 345 (5,332) - 1,199
-------- -------- --------- --------- -------- -------- -------- -------- -------- ---------
Re-estimated reserves at
beginning of 2007 ............. $ 6,206 $ 559 $ (8,738) $ 2,125 $ 2,093 $ 4,741 $12,396 $23,898 $ - $ 43,280
======== ======== ========= ========= ======== ======== ======== ======== ======== =========
Reserves at beginning of 2008 ... $ 4,843 $ 170 $(10,139) $ 1,028 $ 1,154 $ 1,855 $ 5,660 $13,618 $27,677 $ 45,866
Development during 2008 ......... 1,129 85 749 (100) 647 40 125 (884) 280 2,071
-------- -------- --------- --------- -------- -------- -------- -------- -------- ---------
Re-estimated reserves at
beginning of 2008 ............. $ 5,972 $ 255 $ (9,390) $ 928 $ 1,801 $ 1,895 $ 5,785 $12,734 $27,957 $ 47,937
======== ======== ========= ========= ======== ======== ======== ======== ======== =========
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.
During 2008, NAICO experienced adverse loss development totaling $2.1
million primarily in the workers compensation line of business in the
standard lines program. A portion of the adverse loss development was
offset by favorable development in the automobile liability line of
business in this program. The adverse loss development included
approximately $166,000 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 2006, 2007 and 2008, NAICO incurred charges of $97,000, $356,000 and
$166,000, 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, 2006, 2007 and 2008:
YEAR ENDED DECEMBER 31,
--------------------------------
2006 2007 2008
---------- ---------- ----------
(In thousands)
Commissions expense .............................. $ 15,933 $ 13,987 $ 14,029
Other premium related assessments ................ 1,061 1,020 1,098
Premium taxes .................................... 2,020 2,014 1,965
Excise taxes ..................................... 272 280 266
Other expense .................................... 730 789 540
---------- ---------- ----------
Total direct expenses ............................ 20,016 18,090 17,898
Indirect underwriting expenses ................... 6,296 5,906 6,322
Commissions received from reinsurers ............. (15,026) (11,176) (11,686)
Adjustment for deferred acquisition costs ........ 380 (273) (186)
---------- ---------- ----------
Net policy acquisition costs ..................... $ 11,666 $ 12,547 $ 12,348
========== ========== ==========
Total gross direct and indirect expenses as a percentage of direct written
and assumed premiums were 23.3% in 2006, 24.0% in 2007 and 24.6% in 2008.
For these periods, commission expense as a percentage of gross written and
assumed premiums was 14.1%, 14.0% and 14.3%.
Indirect underwriting expenses were 5.6%, 5.9% and 6.4% of total direct
written and assumed premiums in 2006, 2007 and 2008, 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. The increase in indirect
underwriting expenses during 2008 was primarily due to increased marketing
costs. 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 31.1%, 31.4% and 32.4% in
2006, 2007 and 2008, respectively.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were 10.8%, 11.8% and 12.7% of gross
premiums earned and other income in 2006, 2007 and 2008, 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. The increase in the 2008 percentage was due to a decrease in gross
premiums earned of $5.9 million along with an increase of 2.6% in general
and administrative expenses. 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 less than 1% in 2007 and decreased 5.0% in 2008.
Substantially all of Chandler USA's interest expense is related to its
outstanding senior debentures and junior subordinated debentures. The
decrease in 2008 was due primarily to the decrease 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 32.9%, 11.6% and 56.4% for 2006, 2007
and 2008, respectively. The 2007 percentage decreased due primarily to the
impact of nondeductible expenses on the net loss before income taxes. The
2008 percentage increased due primarily to the impact of nondeductible
expenses on net income before income taxes.
At December 31, 2008, Chandler USA had a net deferred tax asset of $2.7
million. Chandler USA believes it is more likely than not that the deferred
income tax asset 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 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, 2008, NAICO had statutory earned surplus of $13.4
million. Applying the Oklahoma statutory limits described above, the
maximum shareholder dividend NAICO may pay in 2009 without the approval
of the Oklahoma Department of Insurance is $5.1 million. NAICO paid
shareholder dividends to Chandler USA totaling $1.6 million and $2.1
million during 2007 and 2008, respectively.
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. 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. At December 31, 2008, all but
$3.2 million or 4% of total fixed maturity investments were rated AA or
better by Moody's Investor Service, Inc. or Standard & Poor's. The
remaining fixed maturities were rated A by Moody's Investor Service, Inc.,
and Baa1 or A2 by Standard & Poor's.
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, 2008, 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 provided $4.4 million, $8.7 million and $6.0 million in cash
from operations in 2006, 2007 and 2008, respectively. 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." The cash
provided by operations in 2008 included a decrease in reinsurance
recoverable on unpaid losses of $2.3 million, a decrease in premiums
receivable of $1.7 million, a decrease in prepaid reinsurance premiums of
$948,000 and an increase in unpaid losses of $869,000. These were partially
offset by a decrease in unearned premiums of $2.7 million.
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 $745,000, $214,000 and $95,000 during 2006, 2007
and 2008, respectively, from the sale of investments. NAICO received
proceeds of $21.3 million, $17.6 million and $6.7 million during 2006, 2007
and 2008, 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 $1,000 in 2006 and increased $2.2 million
and $1.9 million in 2007 and 2008, respectively, due primarily to changes
in interest rates and other economic conditions experienced during this time.
The average maturity of NAICO's fixed maturity investments was 2.6 years and
3.7 years at December 31, 2007 and 2008, 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, 2007 and 2008,
Chandler USA had a receivable of $11.5 million and $11.9 million,
respectively, under the Credit Agreement, and Chandler USA earned $733,000,
$881,000 and $590,000 in interest income under the Credit Agreement during
2006, 2007 and 2008, 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, 2008, the total amount of cash and investments
restricted as a result of these arrangements was $8.6 million. In addition,
NAICO has deposited $27.0 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 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
4.25% at December 31, 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. See Note 12 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, 2008, 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) ....................... $ 38,141 $ 45,009 $ 14,179 $ 4,130 $ 101,459
Future minimum rental payments
under operating leases ............. 424 137 - - 561
Guaranteed residual value of
operating lease (2) ................ - 1,518 - - 1,518
Capital leases ....................... 70 82 27 - 179
Debentures ........................... - - - 6,979 6,979
Junior subordinated debentures
issued to affiliated trusts ........ - - - 20,620 20,620
---------- --------- --------- --------- ---------
Total .............................. $ 38,635 $ 46,746 $ 14,206 $ 31,729 $ 131,316
========== ========= ========= ========= =========
- ----------------------------------------
<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 11 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.
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. Gulf
Liquids has appealed the judgment entered in favor of 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.
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, 2008, substantially 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
December 31, 2008, all but $3.2 million or 4% of total fixed maturity
investments were rated AA or better by Moody's Investor Service, Inc. or
Standard & Poor's. The remaining fixed maturities were rated A by Moody's
Investor Service, Inc., and Baa1 or A2 by Standard & Poor's. 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 ----------------------
2007 2008 (bp=basis points) 2007 2008
---------- ---------- ----------------- ---------- ----------
(Dollars in thousands) (Dollars in thousands)
Fixed-maturity investments ... $ 63,057 $ 77,096 100 bp increase $ 61,526 $ 74,603
200 bp increase 60,068 72,247
100 bp decrease 64,644 78,678
200 bp decrease 66,312 81,410
The table above illustrates, for example, that an instantaneous 200 basis
point increase in market interest rates at December 31, 2008 would reduce
the estimated fair value of NAICO's fixed-maturity investments by
approximately $4.8 million at that date.
PAGE 37
NAICO's portfolio of equities 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. At December 31, 2007 and 2008, Chandler USA's
equity securities consisted of common stock received in connection with an
unaffiliated entity's conversion to a for-profit corporation. The equities
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% decrease and a 20% increase in market prices as of
December 31, 2007 and 2008. 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 ----------------------
2007 2008 price change 2007 2008
---------- ---------- ----------------- ---------- ----------
(Dollars in thousands) (Dollars in thousands)
Equity securities ........ $ 141 $ 76 20% increase .... $ 169 $ 91
20% decrease .... 113 61
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, 2008, the fair value of Chandler
USA's Debentures was estimated to be $5.6 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 8.92% at December 31, 2008. At December
31, 2008, the fair value of Chandler USA's junior subordinated debentures
was estimated to be $24.6 million.
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 4.25%
at December 31, 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.
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, 2008.
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 63 Chairman of the Board, Chief Executive Officer, Compensation
Committee Member and Director.
Mark T. Paden 52 President, Compensation Committee Member and Director.
Lance A. LaGere 28 Executive Vice President and Chief Operating Officer.
Richard L. Evans 62 Senior Vice President and Director.
R. Patrick Gilmore 57 Senior Vice President, Secretary, General Counsel and Director.
Mark C. Hart 53 Senior Vice President-Finance, Chief Financial Officer and Treasurer.
M. Steven Blain 51 Vice President.
Robert L. Rice 74 Audit Committee Chairman and Director.
W. Scott Martin 58 Audit Committee Member and Director.
William T. Keele 72 Audit Committee Member and Director.
W. BRENT LAGERE has been a director, Chairman of the Board and Chief
Executive Officer of NAICO since 1987, Chandler USA since 1988 and CIMI
since December 2002. Mr. LaGere has also served as President of NAICO from
August 1987 to October 1989, and from May 1997 to May 2001. Mr. LaGere
also served as President of Chandler USA from June 1988 to October 1989 and
from May 1997 to May 2001. 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 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 and First Bank in
Burkburnett, Texas. 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, 2008.
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
2008, the following base salaries were approved for our named executive
officers:
PERCENTAGE
NAMED EXECUTIVE OFFICER 2008 BASE SALARY INCREASE
------------------------------------ ---------------- ----------
W. Brent LaGere .................... $ 589,360 4.9%
Mark T. Paden ...................... 354,037 3.0%
Richard L. Evans ................... 293,942 3.0%
R. Patrick Gilmore ................. 263,695 3.0%
Mark C. Hart ....................... 182,586 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 2008, 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 2008 $ 566,419 $ 735,482 $ 608,574 $ 1,910,475
and CEO 2007 549,255 504,777 1,432,763 2,486,795
2006 537,544 574,269 819,886 1,931,699
Mark T. Paden, President 2008 353,178 132,000 105,171 590,349
2007 342,891 183,000 155,994 681,885
2006 332,904 563,432 98,204 994,540
Richard L. Evans, Senior 2008 293,229 - 25,808 319,037
Vice President - Claims 2007 284,688 8,000 22,972 315,660
2006 276,396 - 21,383 297,779
R. Patrick Gilmore, Senior Vice President, 2008 258,574 25,000 14,169 297,743
Secretary and General Counsel 2007 251,043 8,000 14,867 273,910
2006 243,731 - 13,102 256,833
Mark C. Hart, Senior Vice President - Finance, 2008 180,592 - 6,225 186,817
Chief Financial Officer and Treasurer 2007 175,332 15,000 6,225 196,557
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 ......... 2008 $ 6,225 $ 82,075 $ 267,528 $ 252,746 $ 608,574
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 ........... 2008 6,225 3,900 53,425 41,621 105,171
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 ........ 2008 6,225 5,000 12,219 2,364 25,808
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 ...... 2008 6,225 1,900 5,146 898 14,169
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 ............ 2008 6,225 - - - 6,225
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 $1,900 for Mr. Gilmore during 2008) 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 during 2008 included company provided automobiles and payment of disability insurance
premiums 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 and
payments for miscellaneous personal expenses. Mr. LaGere's personal expenses also included legal and tax preparation
services, personal flights on company provided aircraft, payments related to personally owned watercraft of $43,144 in
2008 and payments for personal charges on personal credit cards of $148,379 during 2008. 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.
(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 ................... 2008 $ 13,125 $ 13,125
2007 12,375 12,375
2006 12,375 12,375
W. Scott Martin .................. 2008 11,250 11,250
2007 11,250 11,250
2006 10,750 10,750
William T. Keele ................. 2008 11,250 11,250
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 3, 2009 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 28, 2009, 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 285,266 80.0%
Series B Preferred Shares 75,757 80.0%
Series C Preferred Shares 113,134 17.9%
Mark T. Paden (4) .......................................... Class A Common Shares 125,165 20.0%
Series A Preferred Shares 71,317 20.0%
Series B Preferred Shares 18,939 20.0%
Series C Preferred Shares 28,283 4.5%
Lance A. LaGere (5) ........................................ Class A Common Shares 370,890 59.3%
Series A Preferred Shares 211,311 59.3%
Series B Preferred Shares 56,117 59.3%
Series C Preferred Shares 83,804 13.3%
Richard L. Evans ........................................... Series C Preferred Shares 937 0.1%
All directors and officers as a group (4 persons) .......... Class A Common Shares 625,826 100.0%
Series A Preferred Shares 356,583 100.0%
Series B Preferred Shares 94,696 100.0%
Series C Preferred Shares 142,354 22.5%
- -------------------------------------------------------------
<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, 356,583 Series A Preferred Shares of Chandler Insurance,
94,696 Series B Preferred Shares of Chandler Insurance and 632,069 Series C Preferred Shares of Chandler Insurance
outstanding on February 28, 2009.
(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. Also includes 211,311 Series A Preferred Shares, 56,117
Series B Preferred Shares and 83,804 Series C Preferred Shares owned by the LaGere Trust. Mr. LaGere has no right to
vote and disclaims beneficial ownership of the shares held by the LaGere Trust and W&L Holding. To secure a personal
loan, Mr. LaGere has pledged 32,491 Class A Common Shares, 73,955 Series A Preferred Shares, 19,640 Series B Preferred
Shares and 29,330 Series C Preferred Shares. The business address of Mr. LaGere is 1010 Manvel Avenue, Chandler,
Oklahoma 74834.
(4) Includes 125,165 Class A Common Shares of Chandler Insurance owned by the Mark T. Paden Living Trust (the "Paden Trust").
Mr. Paden is a co-trustee of the Paden Trust. As a co-trustee of the Paden Trust, Mr. Paden may vote the Class A Common
Shares. Also includes 71,317 Series A Preferred Shares, 18,939 Series B Preferred Shares and 28,283 Series C Preferred
Shares owned by the Paden Trust. To secure a personal loan, 8,169 Class A Common Shares, 71,317 Series A Preferred
Shares, 18,939 Series B Preferred Shares and 28,283 Series C Preferred Shares owned by the Paden Trust have been pledged.
The business address of Mr. Paden is 1010 Manvel Avenue, Chandler, Oklahoma 74834.
PAGE 45
(5) Includes (i) 348,390 Class A Common Shares of Chandler Insurance owned by the LaGere Trust and (ii) 22,500 Class A Common
Shares of Chandler Insurance owned by W&L Holding. Also includes 211,311 Series A Preferred Shares, 56,117 Series B
Preferred Shares and 83,804 Series C Preferred Shares owned by the LaGere Trust. Lance A. LaGere is a co-trustee of the
LaGere Trust. As such, he shares with Malinda K. LaGere Laird and Mathew C. LaGere the right to vote the Class A Common
Shares. To secure a loan, the LaGere Trust has pledged 211,311 Series A Preferred Shares, 56,117 Series B Preferred
Shares and 83,804 Series C Preferred Shares.
SHAREHOLDERS HOLDING OVER FIVE PERCENT
Listed below are persons, other than those listed previously, who are
known by Chandler USA to own beneficially more than 5% of Chandler
Insurance's Class A Common Shares as of February 28, 2009. 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
---------------------------------------------------------------
TYPE OF CAPITAL SHARES NUMBER OF
NAME OF SHAREHOLDER OF CHANDLER INSURANCE CAPITAL SHARES (1) PERCENT (2)
- ------------------------------------------------ -------------------------- -------------------- --------------
Malinda K. LaGere Laird, Mathew C. LaGere and Class A Common Shares 370,890 59.3%
Lance A. LaGere, Successor Co-Trustees of Series A Preferred Shares 211,311 59.3%
the W. Brent LaGere Irrevocable Trust Series B Preferred Shares 56,117 59.3%
1010 Manvel Avenue, Chandler, Oklahoma 74834 (3) Series C Preferred Shares 83,804 13.3%
- --------------------------------------------------------------------
<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. 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 outstanding on February 28, 2009.
(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. To secure a loan, the LaGere Trust
has pledged 211,311 Series A Preferred Shares, 56,117 Series B Preferred Shares and 83,804 Series C Preferred Shares.
CHANGES IN CONTROL
As described previously, certain capital shares of Chandler Insurance have
been pledged to a bank to secure loans, including Class A Common Shares and
Series A Preferred Shares. The Series A Preferred Shares of Chandler
Insurance are convertible to Class A Common Shares of Chandler Insurance.
A change in control could result from a foreclosure of these shares if the
Series A Preferred Shares are converted to Class A Common Shares.
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.
PAGE 46
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 12 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 balances maintained by Chandler USA and each subsidiary are
fully insured by the FDIC, and Chandler USA and its subsidiaries pay
customary service charges to the bank for the services provided.
During 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, 2008. 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. During
2008, the drilling rig was stacked due to the current economic environment
until it can be re-deployed in the future when economic conditions and the
demand for drilling rigs improves. CIMI recorded a reserve for possible
loss in the partnership of $252,000 plus accrued interest in the amount of
$10,000 as of December 31, 2008.
During 2008, W. Brent LaGere, the LaGere Trust and the Paden Trust pledged
certain capital shares of Chandler Insurance to a bank to secure certain
loans made by the bank to these parties. W. Scott Martin, a director of
NAICO and Chandler USA, is a director of the bank and a significant
shareholder of the bank holding company that provided these bank loans.
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 certain other expenses.
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 2006, 2007 and 2008, Chandler USA incurred approximately $308,000,
$302,000 and $361,000, respectively, in expenses associated with its use
of this property, including $11,000, $3,000 and $4,000 for reimbursement
of certain expenses, such as utility and similar expenses, for the years
2006, 2007 and 2008, respectively.
DIRECTOR INDEPENDENCE
Chandler USA is a privately held corporation with only debt securities
listed on the NYSE Alternext US LLC ("NYSE Alternext") exchange (formerly
known as the American Stock Exchange). NYSE Alternext requires that a
majority of the directors be "independent directors" as defined in the NYSE
Alternext's 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 HoganTaylor 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 $186,400 and $195,800
for the years ended December 31, 2007 and 2008, respectively.
AUDIT-RELATED FEES
The aggregate fees billed for professional services rendered by
HoganTaylor LLP for audit related services rendered in connection with the
audits of employee benefit plans and consultation on accounting standards
or transactions were $18,500 and $19,500 for the years ended December 31,
2007 and 2008, respectively.
PAGE 47
TAX FEES
The aggregate fees billed or to be billed for professional services
rendered by HoganTaylor LLP for tax compliance, tax advice and tax planning
were $39,675 and $46,670 for the years ended December 31, 2007 and 2008,
respectively.
ALL OTHER FEES
There were no fees billed by HoganTaylor LLP for professional services
other than those reported in the categories above for the years ended
December 31, 2007 and 2008.
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 23.8% and 25.3% for the years ended December 31, 2007 and 2008,
respectively.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
(a) 1. FINANCIAL STATEMENTS. The consolidated balance sheets of
Chandler USA and its subsidiaries as of December 31, 2007 and
2008, 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, 2008,
together with the related notes thereto and the report of
HoganTaylor 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)
PAGE 48
10.6 Amended and Restated Declaration of Trust of Chandler
Capital Trust I dated as of May 22, 2003 among Chandler
(U.S.A.), Inc., as sponsor, Wilmington Trust Company,
as Delaware trustee, Wilmington Trust Company, as
institutional trustee, and W. Brent LaGere, Mark T.
Paden and Mark C. Hart, as administrators. (4)
10.7 Indenture, dated as of May 22, 2003 among Chandler
(U.S.A.), Inc., as issuer, and Wilmington Trust
Company, as trustee. (4)
10.8 Guarantee Agreement, dated as of May 22, 2003 between
Chandler (U.S.A.), Inc., as guarantor, and Wilmington
Trust Company, as guarantee trustee. (4)
10.9 Capital Securities Subscription Agreement dated as of
May 13, 2003 among Chandler (U.S.A.), Inc. and Chandler
Capital Trust I, together as offerors, and InCapS
Funding I, Ltd., as purchaser. (4)
10.10 Placement Agreement dated May 13, 2003 among Chandler
(U.S.A.), Inc. and Chandler Capital Trust I, together
as offerors, and Sandler O'Neill & Partners, L.P., as
placement agent. (4)
10.11 Amended and Restated Declaration of Trust of Chandler
Capital Trust II dated as of December 16, 2003 among
Chandler (U.S.A.), Inc., as sponsor, Wilmington Trust
Company, as Delaware trustee, Wilmington Trust Company,
as institutional trustee, and W. Brent LaGere, Mark T.
Paden and Mark C. Hart, as administrators. (6)
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 3, 2009 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 3, 2009 /s/ W. Brent LaGere
----------------------------------------------------
W. Brent LaGere, Chairman of the Board,
Chief Executive Officer and Director
(Principal Executive Officer)
Date: March 3, 2009 /s/ Mark T. Paden
----------------------------------------------------
Mark T. Paden, President and Director
Date: March 3, 2009 /s/ Mark C. Hart
----------------------------------------------------
Mark C. Hart, Senior Vice President - Finance,
Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer)
Date: March 3, 2009 /s/ Richard L. Evans
----------------------------------------------------
Richard L. Evans, Senior Vice President and Director
Date: March 3, 2009 /s/ R. Patrick Gilmore
----------------------------------------------------
R. Patrick Gilmore, Senior Vice President,
Secretary, General Counsel and Director
Date: March 3, 2009 /s/ Robert L. Rice
----------------------------------------------------
Robert L. Rice, Director
Date: March 3, 2009 /s/ W. Scott Martin
----------------------------------------------------
W. Scott Martin, Director
Date: March 3, 2009 /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, 2007 and 2008 ................................. F-2
Consolidated Statements of Operations for the years ended
December 31, 2006, 2007 and 2008 ............................................................ F-3
Consolidated Statements of Comprehensive Income for the years ended
December 31, 2006, 2007 and 2008 ............................................................ F-4
Consolidated Statements of Cash Flows for the years ended
December 31, 2006, 2007 and 2008 ............................................................ F-5
Consolidated Statements of Shareholder's Equity for the years ended
December 31, 2006, 2007 and 2008 ............................................................ F-6
Notes to Consolidated Financial Statements ................................................... F-7 through F-27
Report of Independent Registered Public Accounting Firm on Consolidated Financial Statements
and Financial Statement Schedules ........................................................... F-28
SCHEDULES
I Summary of Investments - Other Than Investments in Related Parties ................... F-29
II Condensed Financial Information of Registrant ........................................ F-30 through F-32
III Supplementary Insurance Information .................................................. F-33
IV Reinsurance .......................................................................... F-34
V Valuation and Qualifying Accounts .................................................... F-35
VI Supplemental Information (for property-casualty insurance underwriters) .............. F-36
PAGE F-2
CHANDLER (U.S.A.), INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands except share amounts)
DECEMBER 31,
-----------------------
2007 2008
---------- ----------
ASSETS
Investments
Fixed maturities available for sale, at fair value
Restricted (amortized cost $32,416 and $34,243 in 2007 and 2008, respectively) ......... $ 32,670 $ 35,397
Unrestricted (amortized cost $30,484 and $40,771 in 2007 and 2008, respectively) ....... 30,387 41,699
Equity securities at fair value (cost $0 in 2007 and 2008) ............................... 141 76
Short-term investments at fair value (amortized cost $1,045 and $5,853 in 2007
and 2008, respectively) ................................................................ 1,045 5,865
---------- ----------
Total investments ...................................................................... 64,243 83,037
Cash and cash equivalents ($146 and $118 restricted in 2007 and 2008, respectively) ........ 32,956 20,636
Accrued investment income .................................................................. 874 1,018
Premiums receivable, less allowance for non-collection of $134 and $138 at
2007 and 2008, respectively .............................................................. 28,128 26,405
Reinsurance recoverable on paid losses ..................................................... 1,100 423
Reinsurance recoverable on unpaid losses, less allowance for non-collection
of $239 and $231 at 2007 and 2008, respectively .......................................... 36,036 32,492
Reinsurance recoverable on unpaid losses from related parties .............................. 18,688 19,899
Prepaid reinsurance premiums ............................................................... 3,105 2,882
Prepaid reinsurance premiums to related parties ............................................ 12,928 12,203
Deferred policy acquisition costs .......................................................... 1,118 1,304
Property and equipment, net ................................................................ 8,255 7,849
Amounts due from related parties ........................................................... 11,506 11,869
State insurance licenses, net .............................................................. 3,745 3,745
Other assets ............................................................................... 11,685 10,885
---------- ----------
Total assets ............................................................................... $ 234,367 $ 234,647
========== ==========
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Unpaid losses and loss adjustment expenses ............................................... $ 100,590 $ 101,459
Unearned premiums ........................................................................ 46,389 43,725
Policyholder deposits .................................................................... 7,947 7,820
Accrued taxes and other payables ......................................................... 5,777 6,017
Premiums payable ......................................................................... 2,263 2,440
Premiums payable to related parties ...................................................... 198 222
Debentures ............................................................................... 6,979 6,979
Junior subordinated debentures issued to affiliated trusts ............................... 20,620 20,620
---------- ----------
Total liabilities ...................................................................... 190,763 189,282
---------- ----------
Commitments and contingencies (Notes 11 and 12)
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 ...................................................................... (17,179) (16,654)
Accumulated other comprehensive income:
Unrealized gain on investments available for sale, net of deferred income taxes ........ 197 1,433
---------- ----------
Total shareholder's equity ............................................................. 43,604 45,365
---------- ----------
Total liabilities and shareholder's equity ................................................. $ 234,367 $ 234,647
========== ==========
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,
--------------------------------------
2006 2007 2008
------------ ------------ ------------
Premiums and other revenues
Direct premiums written and assumed .................................... $ 113,043 $ 100,081 $ 98,384
Reinsurance premiums ceded ............................................. (21,098) (7,690) (9,476)
Reinsurance premiums ceded to related parties .......................... (27,156) (27,959) (26,596)
------------ ------------ ------------
Net premiums written and assumed ...................................... 64,789 64,432 62,312
Decrease in unearned premiums .......................................... 915 1,753 1,715
------------ ------------ ------------
Net premiums earned ................................................... 65,704 66,185 64,027
Investment income (loss), net ........................................... 9,801 (572) 3,347
Interest income, net from related parties ............................... 792 941 647
Realized investment gains, net .......................................... 745 214 95
Other income ............................................................ 317 1,916 2,069
------------ ------------ ------------
Total premiums and other revenues ..................................... 77,359 68,684 70,185
------------ ------------ ------------
Operating costs and expenses
Losses and loss adjustment expenses, net of amounts ceded
to related parties of $14,007, $16,808 and $15,532
in 2006, 2007 and 2008, respectively .................................. 45,473 41,393 40,940
Policy acquisition costs, net of ceding commissions received
from related parties of $10,445, $10,633 and $10,112
in 2006, 2007 and 2008, respectively .................................. 11,666 12,547 12,348
General and administrative expenses .................................... 12,469 12,790 13,124
Interest expense ....................................................... 2,690 2,703 2,569
------------ ------------ ------------
Total operating costs and expenses .................................... 72,298 69,433 68,981
------------ ------------ ------------
Income (loss) before income taxes ....................................... 5,061 (749) 1,204
Federal income tax benefit (provision) .................................. (1,665) 87 (679)
------------ ------------ ------------
Income (loss) ........................................................... $ 3,396 $ (662) $ 525
============ ============ ============
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,
--------------------------------------
2006 2007 2008
------------ ------------ ------------
Net income (loss) ........................................................... $ 3,396 $ (662) $ 525
------------ ------------ ------------
Other comprehensive income (loss), before income tax:
Unrealized gains on securities:
Unrealized holding gains arising during period ............................ 566 2,187 1,968
Less: Reclassification adjustment for gains included in net income (loss).. (745) (214) (95)
------------ ------------ ------------
Other comprehensive income (loss), before income tax ........................ (179) 1,973 1,873
Income tax benefit (provision) related to items of other
comprehensive income (loss) ................................................ 61 (671) (637)
------------ ------------ ------------
Other comprehensive income (loss), net of income tax ........................ (118) 1,302 1,236
------------ ------------ ------------
Comprehensive income ........................................................ $ 3,278 $ 640 $ 1,761
============ ============ ============
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,
--------------------------------------
2006 2007 2008
------------ ------------ ------------
OPERATING ACTIVITIES
Net income (loss) ...................................................... $ 3,396 $ (662) $ 525
Add (deduct):
Adjustments to reconcile net income (loss) to cash
provided by operating activities:
Realized investment gains, net ....................................... (745) (214) (95)
Net (gains) losses on sale of property and equipment ................. 20 (6) 7
Amortization and depreciation ........................................ 1,379 1,431 1,555
Provision for non-collection of premiums ............................. 80 19 30
Provision for non-collection of reinsurance recoverables ............. 97 356 166
Provision for non-collection of debenture ............................ - - 262
Net change in non-cash balances relating to operating activities:
Accrued investment income ........................................... (4,135) 4,148 (144)
Premiums receivable ................................................. (2,742) 2,861 1,693
Reinsurance recoverable on paid losses .............................. 1,647 (260) 503
Reinsurance recoverable on unpaid losses ............................ 29,164 (10,557) 3,552
Reinsurance recoverable on unpaid losses from related parties ....... (1,300) (3,104) (1,211)
Prepaid reinsurance premiums ........................................ 2,160 4,498 223
Prepaid reinsurance premiums to related parties ..................... (1,259) 578 725
Deferred policy acquisition costs ................................... 380 (273) (186)
Other assets ........................................................ 2,129 (1,373) (156)
Unpaid losses and loss adjustment expenses .......................... (26,288) 17,337 869
Unearned premiums ................................................... (1,817) (6,828) (2,664)
Policyholder deposits ............................................... 1,979 284 (127)
Accrued taxes and other payables .................................... (441) 997 240
Premiums payable .................................................... (226) 308 177
Premiums payable to related parties ................................. 889 (804) 24
------------ ------------ ------------
Cash provided by operating activities ................................ 4,367 8,736 5,968
------------ ------------ ------------
INVESTING ACTIVITIES
Short-term investments:
Purchases ............................................................. - (1,330) (6,424)
Maturities ............................................................ - 285 1,615
Unrestricted fixed maturities available for sale:
Purchases ............................................................. (995) (13,585) (38,722)
Sales ................................................................. - 10,120 6,417
Maturities ............................................................ 5,809 8,588 19,682
Equity securities available for sale:
Purchases ............................................................. (13,620) (5,811) (266)
Sales ................................................................. 21,336 7,457 270
Cost of property and equipment purchased ............................... (688) (696) (642)
Proceeds from sale of property and equipment ........................... 71 50 145
Investment in limited partnership ...................................... (502) - -
------------ ------------ ------------
Cash provided by (applied to) investing activities ................... 11,411 5,078 (17,925)
------------ ------------ ------------
FINANCING ACTIVITIES
Payments and loans from related parties ................................ 1,747 2,164 2,639
Payments and loans to related parties .................................. (1,971) (4,086) (3,002)
Bank loan proceeds ..................................................... 500 - -
Payments on bank loan .................................................. (161) (339) -
------------ ------------ ------------
Cash provided by (applied to) financing activities ................... 115 (2,261) (363)
------------ ------------ ------------
Increase (decrease) in cash and cash equivalents during the period ..... 15,893 11,553 (12,320)
Cash and cash equivalents at beginning of period ....................... 5,510 21,403 32,956
------------ ------------ ------------
Cash and cash equivalents at end of period ............................. $ 21,403 $ 32,956 $ 20,636
============ ============ ============
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, 2006 ......... $ 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
----------- ----------- ----------- ------------- -------------
Net income ....................... - - 525 - 525
Change in unrealized gain on
investments available for
sale, net of income tax ......... - - - 1,236 1,236
----------- ----------- ----------- ------------- -------------
Balance, December 31, 2008 ....... $ 2 $ 60,584 $ (16,654) $ 1,433 $ 45,365
=========== =========== =========== ============= =============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
PAGE F-7
CHANDLER (U.S.A.), INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2006, 2007 AND 2008
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 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 4, 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:
2007 2008
---------- ----------
(In thousands)
Real estate and improvements ... $ 11,967 $ 12,058
Other property and equipment ... 8,577 8,803
---------- ----------
20,544 20,861
Accumulated depreciation ....... (12,289) (13,012)
---------- ----------
$ 8,255 $ 7,849
========== ==========
Depreciation expense was approximately $780,000, $854,000 and
$896,000 for 2006, 2007 and 2008, 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 2007
and 2008 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:
2007 2008
---------- ----------
(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,
--------------------------------
2006 2007 2008
---------- ---------- ----------
(In thousands)
Cash payments during the year for:
Interest ....................................... $ 2,608 $ 2,649 $ 2,517
Income taxes ................................... - 25 1,220
Transfers to restricted securities, net .......... $ (8,127) $ (12,726) $ (1,619)
(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 12, 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 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
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 Postretirement 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 does not expect
the adoption of SFAS No. 161 to have a material impact on its
consolidated financial statements.
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.
PAGE F-11
NOTE 2. 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 December 31, 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 December 31, 2008.
Fair value measurements at December 31, 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 .... $ - $ 77,096 $ - $ 77,096
Equity securities available for sale ... - - 76 76
Short-term investments ................. - 5,865 - 5,865
---------------- --------------- ---------------- -----------
Total ................................. $ - $ 82,961 $ 76 $ 83,037
================ =============== ================ ===========
Prices for fixed maturities available for sale and short-term
investments were provided by various custodians that hold such assets on
behalf of Chandler USA. The custodians utilize independent pricing services
to determine prices for these assets. Management reviews the prices
provided but does not conduct an independent validation of the prices. Any
fixed maturities that are not held by a custodian are priced using non-
binding broker quotations. Total assets priced from broker quotations
totaled $387,000 at December 31, 2008, or 0.5% of total Level 2 assets.
PAGE F-12
At December 31, 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 year ended December 31, 2008.
Fair value measurements using significant Year ended
unobservable inputs (Level 3) December 31, 2008
------------------------------------------------- -----------------
(In thousands)
Beginning balance ............................. $ 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
=================
NOTE 3. 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,
--------------------------------
2006 2007 2008
---------- ---------- ----------
(In thousands)
Interest on fixed-maturity investments ................... $ 2,829 $ 2,818 $ 2,929
Interest on short-term investments and cash equivalents .. 574 1,069 692
Dividend income on equity securities ..................... 58 11 1
Prejudgment interest related to litigation ............... 6,648 (4,148) -
Investment expenses ...................................... (308) (322) (275)
---------- ---------- ----------
Investment income, net ................................. 9,801 (572) 3,347
---------- ---------- ----------
Realized gains, net - fixed-maturity investments ......... - 154 91
Realized gains, net - equity securities .................. 745 60 4
---------- ---------- ----------
Realized investment gains, net ......................... 745 214 95
---------- ---------- ----------
$ 10,546 $ (358) $ 3,442
========== ========== ==========
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 11 for more information related to
this litigation.
Investment expenses include $164,000, $193,000 and $128,000 for the
years ended December 31, 2006, 2007 and 2008, respectively, in expense to
subsidize a premium finance program for certain insureds of NAICO with an
unaffiliated premium finance company.
PAGE F-13
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, 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
========== ========== ========== ========== ==========
GROSS GROSS
UNREALIZED UNREALIZED FAIR CARRYING
DECEMBER 31, 2008 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 ................................... $ 39,151 $ 2,349 $ - $ 41,500 $ 41,500
Corporate obligations ............................. 29,558 313 (386) 29,485 29,485
Public utilities .................................. 3,108 21 (153) 2,976 2,976
Obligations of states and political subdivisions... 3,197 12 (74) 3,135 3,135
---------- ---------- ---------- ---------- ----------
$ 75,014 $ 2,695 $ (613) $ 77,096 $ 77,096
========== ========== ========== ========== ==========
EQUITY SECURITIES:
Corporate stock ................................... $ - $ 76 $ - $ 76 $ 76
========== ========== ========== ========== ==========
Excluding investments in bonds and notes of the U.S. Government and U.S.
Government agencies and authorities, Chandler USA did not hold any fixed
maturity investments that exceeded 10% of shareholder's equity at December
31, 2007. At December 31, 2008, Chandler USA held investments in fixed
maturities issued by General Electric Capital Corporation with a fair value
of $4.6 million or 10.1% of shareholder's equity.
The fair value of Chandler USA's investments with sustained gross
unrealized losses at December 31, 2008 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 .......... $ - $ - $ - $ - $ - $ -
Corporate securities ................. 9,027 (323) 7,697 (63) 16,724 (386)
Public utilities ..................... 1,914 (153) - - 1,914 (153)
Obligations of states and political
subdivisions ....................... 2,147 (74) - - 2,147 (74)
----------- ---------- ----------- ---------- ----------- ----------
$ 13,088 $ (550) $ 7,697 $ (63) $ 20,785 $ (613)
=========== ========== =========== ========== =========== ==========
The unrealized losses of Chandler USA's fixed maturity investments were
primarily caused by changes in market interest rates since the date of
purchase, current conditions in the capital markets and the impact of those
conditions on market prices. 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, 2008.
PAGE F-14
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, 2008 are shown below:
AVAILABLE FOR SALE
------------------------
AMORTIZED
COST FAIR VALUE
------------ ----------
(In thousands)
Due in one year or less .......................... $ 8,466 $ 8,553
Due after one year through five years ............ 55,308 56,919
Due after five years through ten years ........... 10,023 10,403
Due after ten years .............................. 1,217 1,221
------------ ----------
$ 75,014 $ 77,096
============ ==========
Realized gains and losses from sales of investments are shown below:
2006 2007 2008
-------- -------- --------
(In thousands)
FIXED MATURITIES:
Gross realized gains ............................. $ - $ 191 $ 148
Gross realized losses ............................ - (37) (57)
-------- -------- --------
Total net realized gains ........................ $ - $ 154 $ 91
======== ======== ========
EQUITY SECURITIES:
Gross realized gains ............................. $ 855 $ 229 $ 4
Gross realized losses ............................ (110) (169) -
-------- -------- --------
Total net realized gains ........................ $ 745 $ 60 $ 4
======== ======== ========
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, 2007 and 2008, the carrying value of these deposits totaled
approximately $8.0 million and $8.6 million, respectively. In addition,
NAICO has deposited $27.0 million of cash and investments into a trust
account as collateral for a reinsurance agreement in which NAICO is the
assuming reinsurer.
NOTE 4. 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 $11.1 million and $10.9 million at December 31, 2007 and
2008, respectively. Included in these recoverable amounts were net
recoverables of $10.1 million in 2007 and 2008, related to a favorable
jury verdict in civil litigation regarding certain surety bond claims
during 2006. See Note 11 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-15
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,
----------------------------------
2006 2007 2008
---------- ---------- ----------
(In thousands)
Net balance at beginning of year .......................... $ 40,549 $ 42,081 $ 45,866
---------- ---------- ----------
Net losses and loss adjustment expenses incurred related to:
Current year ............................................ 41,644 40,194 38,869
Prior years ............................................. 3,829 1,199 2,071
---------- ---------- ----------
Total ................................................. 45,473 41,393 40,940
---------- ---------- ----------
Net paid losses and loss adjustment expenses related to:
Current year ............................................ (12,403) (12,494) (11,856)
Prior years ............................................. (31,538) (25,114) (25,882)
---------- ---------- ----------
Total ................................................. (43,941) (37,608) (37,738)
---------- ---------- ----------
Net balance at end of year ................................ $ 42,081 $ 45,866 $ 49,068
========== ========== ==========
NAICO experienced a significant amount of incurred losses related to
prior accident years during the 2006 calendar year. Incurred losses related
to prior accident years decreased $2.6 million or 69% in 2007 and increased
$872,000 or 73% in 2008. 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 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.
During 2008, NAICO experienced adverse loss development totaling $2.1
million primarily in the workers compensation line of business in the
standard lines program. A portion of the adverse loss development was
offset by favorable development in the automobile liability line of
business in this program. The adverse loss development included
approximately $166,000 for provisions for potentially uncollectible
reinsurance.
PAGE F-16
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 5. 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, 2008, there were $6,979,000 principal amount
of the Debentures outstanding. As of December 31, 2008, Chandler USA has
capitalized $181,000 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, 2008, Chandler USA was
in compliance with all covenants.
NOTE 6. 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-17
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). The interest rate was 8.92% at December 31, 2008. 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). The interest rate was 8.92% at December
31, 2008. 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, 2008, issuance costs in the
amount of $597,000 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. Under FIN 46R, Chandler USA
reports the $20.6 million of junior subordinated debentures that were issued
to the capital trusts on its consolidated balance sheet.
NOTE 7. 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:
2006 2007 2008
-------- -------- --------
(In thousands)
Statutory net income .............. $ 3,789 $ 1,037 $ 2,375
Statutory capital and surplus ..... $ 51,663 $ 50,250 $ 51,069
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
$404,000, $305,000 and $251,000 at December 31, 2006, 2007 and 2008,
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-18
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, 2007 and 2008.
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 2009 without
the approval of the Oklahoma Department of Insurance is approximately $5.1
million. NAICO paid cash shareholder dividends to Chandler USA totaling
$1.6 million and $2.1 million in 2007 and 2008, respectively. NAICO did
not pay any shareholder dividends during 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 $13.4
million as of December 31, 2008). NAICO paid approximately $4,000 in
policyholder dividends during 2006, respectively. NAICO did not pay any
policyholder dividends during 2007 or 2008.
NOTE 8. 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:
2006 2007 2008
---------- ---------- ----------
(In thousands)
Computed income tax provision (benefit) at 34% ................... $ 1,721 $ (255) $ 409
Increase (decrease) in income taxes resulting from:
Utilization of capital loss carryforward ....................... (253) (73) -
Interest income on the exempt securities ....................... - - (27)
Nondeductible meals and entertainment expenses ................. 163 150 174
Other nondeductible expenses ................................... 34 91 123
---------- ---------- ----------
Federal income tax provision (benefit) ........................... $ 1,665 $ (87) $ 679
========== ========== ==========
U.S. Federal income tax provision (benefit) consists of:
CURRENT DEFERRED TOTAL
---------- ---------- ----------
(In thousands)
2006 ............................................................. $ - $ 1,665 $ 1,665
2007 ............................................................. - (87) (87)
2008 ............................................................. 1,074 (395) 679
PAGE F-19
Deferred income tax provision (benefit) relating to temporary differences
includes the following components:
2006 2007 2008
---------- ---------- ----------
(In thousands)
Loss reserve discounts ........................................... $ 66 $ 9 $ (57)
Unearned premiums ................................................ 62 119 117
Deferred policy acquisition costs ................................ (129) 93 63
Investment in limited partnerships ............................... (152) (40) (7)
Reserve for uncollectible premiums receivable .................... 18 12 (2)
Reserve for non-collection of debenture .......................... - - (89)
Depreciation and lease expense ................................... (70) (49) (52)
Discount on fixed maturity investments ........................... 23 21 (13)
Accrued commissions payable ...................................... - - (261)
Accrual of prejudgment interest income ........................... 1,410 (1,410) -
Net operating loss carryforwards ................................. 530 1,118 -
Other ............................................................ (93) 40 (94)
---------- ---------- ----------
$ 1,665 $ (87) $ (395)
========== ========== ==========
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:
2007 2006
------------ ------------
(In thousands)
Deferred tax assets:
Loss reserve discounts ...................................... $ 2,040 $ 2,098
Unearned premiums ........................................... 2,064 1,948
Compensated absences ........................................ 191 231
Accrued commissions payable ................................. - 261
Net operating loss carryforwards - federal .................. 455 -
Net operating loss carryforwards - state .................... 2,057 2,100
Investment in limited partnership ........................... 318 324
Reserve for non-collection of debenture ..................... - 89
Other ....................................................... 306 337
Valuation allowance ......................................... (2,057) (2,100)
------------ ------------
Total deferred tax assets ..................................... 5,374 5,288
------------ ------------
Deferred tax liabilities:
Depreciation and lease expense .............................. 1,252 1,200
Deferred policy acquisition costs ........................... 380 443
Unrealized gain on investments available for sale ........... 101 738
Other ....................................................... 194 194
------------ ------------
Total deferred tax liabilities ................................ 1,927 2,575
------------ ------------
Net deferred tax assets ....................................... $ 3,447 $ 2,713
============ ============
At December 31, 2007, Chandler USA had a net operating loss carryforward
available for U.S. Federal income taxes of $1.3 million, which was fully
utilized during 2008.
In addition, Chandler USA, at December 31, 2008, had net operating loss
carryforwards available for Oklahoma state income taxes totaling approximately
$35.0 million which expire in the years 2009 through 2028. 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.
Tax years 2005 through 2008 are open to examination by the U.S. Internal
Revenue Service and the Oklahoma Tax Commission.
PAGE F-20
NOTE 9. 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 $307,000, $288,000 and
$293,000 for 2006, 2007 and 2008, respectively.
NOTE 10. 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, 2007 and 2008. The estimated fair values of Chandler USA's
fixed-maturity and equity security investments are disclosed at Note 3. At
December 31, 2008, the fair value of Chandler USA's Debentures was estimated
to be $5.6 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, 2008 was 8.92%. At December 31, 2008, the fair value of
Chandler USA's junior subordinated debentures was estimated to be $24.6
million.
NOTE 11. 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-21
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. 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.
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 12. 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-22
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, 2009.
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 2006, 2007 and 2008, NAICO incurred charges of $97,000, $356,000 and
$166,000, 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:
2006 2007 2008
----------------------- ----------------------- -----------------------
WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED
----------- ---------- ----------- ---------- ----------- ----------
(In thousands)
Direct ........... $ 104,037 $ 109,637 $ 85,836 $ 93,487 $ 90,871 $ 91,367
Assumed .......... 9,006 5,223 14,245 13,422 7,513 9,680
Ceded ............ (48,254) (49,156) (35,649) (40,724) (36,072) (37,020)
----------- ---------- ----------- ---------- ----------- ----------
Net premiums ..... $ 64,789 $ 65,704 $ 64,432 $ 66,185 $ 62,312 $ 64,027
=========== ========== =========== ========== =========== ==========
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 $10.2 million,
$39.5 million and $28.0 million for 2006, 2007 and 2008, 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, 2007 and
2008 were $28.1 million and $26.4 million, respectively. Receivables for
deductibles, in most cases, are secured by cash deposits and letters of
credit. At December 31, 2008, NAICO maintained custody of such letters of
credit securing these and other transactions totaling approximately $27.2
million, which is a reasonable estimate of their fair value. These letters
of credit are not reflected in the accompanying consolidated financial
statements. During 2006, one unaffiliated independent insurance agent
produced approximately 12% of NAICO's direct written and assumed premiums.
There were no unaffiliated independent insurance agents that produced 10%
or more of NAICO's direct written and assumed premiums during 2007 and 2008.
PAGE F-23
Approximately $32.7 million, or 48% of NAICO's reinsurance recoverables
and prepaid reinsurance premiums at December 31, 2008 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, 2008.
CEDED REINSURANCE
NET PREMIUMS FOR A.M. BEST
REINSURANCE THE YEAR ENDED COMPANY
NAME OF REINSURER RECOVERABLE (1) DECEMBER 31, 2008 RATING
- ------------------------------------------------------------- --------------- ------------------ -----------
(Dollars in thousands)
Chandler Insurance ....................................... $ 32,102 $ 26,596 (2)
Swiss Reinsurance America Corporation .................... 15,999 338 A
Westport Insurance Corporation (3) ....................... 13,314 - A
Transatlantic Reinsurance Company ........................ 2,640 1,987 A
Markel Insurance Company ................................. 2,553 1,772 A
--------------- ------------------
Top five reinsurers ................................. $ 66,608 $ 30,693
=============== ==================
All reinsurers ...................................... $ 67,899 $ 36,072
=============== ==================
Percentage of total represented by top five reinsurers ... 98% 85%
- -------------------------------------------------------------
<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, 2008.
(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, 2008, Chandler Insurance had
cash and investments, including accrued interest, with a fair value
of $32.1 million deposited in a trust account for the benefit of NAICO.
(3) Westport Insurance Corporation and Swiss Reinsurance America Corporation
are subsidiaries of Swiss Reinsurance Company.
OTHER
See Note 11 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
$903,000 and $853,000 at December 31, 2007 and 2008, 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 $2,847,000 and $2,732,000 at
December 31, 2007 and 2008, 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-24
At December 31, 2008, Chandler USA's subsidiaries were committed under
noncancellable operating and capital leases for certain equipment and office
space. Rental payments under these leases were $777,000, $648,000 and
$617,000 in 2006, 2007 and 2008, respectively. Future minimum lease
payments are as follows:
(In thousands)
2009 .......................... $ 494
2010 .......................... 170
2011 .......................... 49
2012 .......................... 22
2013 .......................... 5
--------------
$ 740
==============
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 a floating interest rate of 1% over JP Morgan
Chase Bank prime, which was 4.25% at December 31, 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 Trust I and Trust II with
respect to the Trust I Preferred Securities and the Trust II Preferred
Securities. Trust I and Trust II distribute the interest received from
Chandler USA on the junior subordinated debentures to the holders of their
Trust I Preferred Securities and Trust II Preferred Securities to fulfill
their obligations with respect to such securities. Chandler USA 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 13. 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 12 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, 2008. 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. During 2008, the drilling rig was
stacked due to the current economic environment until it can be re-deployed
in the future when economic conditions and the demand for drilling rigs
improves. CIMI recorded a reserve for possible loss in the partnership of
$252,000 plus accrued interest in the amount of $10,000 as of December 31,
2008.
During 2008, a director and officer of Chandler USA and two trusts which
are affiliated with certain directors and officers of Chandler USA pledged
certain capital shares of Chandler Insurance to a bank to secure certain
loans made by the bank to these parties. A director of NAICO and Chandler
USA is a director of the bank and a significant shareholder of the bank
holding company that provided these bank loans.
PAGE F-25
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 $308,000, $302,000 and $361,000 in
expenses associated with this property during 2006, 2007 and 2008,
respectively, including $11,000, $3,000 and $4,000 for reimbursement of
certain expenses, such as utility and similar expenses, for the years
2006, 2007 and 2008, respectively.
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, 2007 and 2008, Chandler USA had a receivable of $11.5 million
and $11.9 million, respectively, under the Credit Agreement, and Chandler
USA earned $733,000, $881,000 and $590,000 in interest income under the
Credit Agreement during 2006, 2007 and 2008, respectively.
NOTE 14. 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 4.1%, 7.0% and 6.7% of 2006, 2007 and
2008 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)
2006
Revenues from external customers (1) ...................... $ 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 (2) ............. 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 (1) ...................... $ 66,753 $ 1,348 $ - $ 68,101
Intersegment revenues ..................................... 99 3,737 (3,836) -
Interest income, net ...................................... 328 41 - 369
Interest expense .......................................... 2,686 17 - 2,703
Segment profit (loss) before income taxes (2) ............. (2,463) 1,714 - (749)
Segment assets ............................................ 232,482 7,772 (5,887) 234,367
Depreciation and amortization ............................. 1,431 - - 1,431
2008
Revenues from external customers (1) ...................... $ 64,532 $ 1,564 $ - $ 66,096
Intersegment revenues ..................................... 56 3,307 (3,363) -
Interest income, net ...................................... 3,967 27 - 3,994
Interest expense .......................................... 2,569 - - 2,569
Segment profit (loss) before income taxes (2) ............. (129) 1,333 - 1,204
Segment assets ............................................ 232,571 9,555 (7,479) 234,647
Depreciation and amortization ............................. 1,555 - - 1,555
- ---------------------------------------------------
<FN>
(1) Consists of net premiums earned and other income.
(2) Includes net realized investment gains.
The following table shows the detail of intersegment eliminations for
segment assets shown in the previous table:
2006 2007 2008
-------- -------- --------
(In thousands)
Segment asset eliminations
Investment in subsidiaries ............................. $ 1 $ 1 $ 1
Elimination of intersegment receivables ................ 5,145 5,886 7,478
-------- -------- --------
$ 5,146 $ 5,887 $ 7,479
======== ======== ========
PAGE F-27
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 2006 2007 2008
- ---------------------------------------------------------- ---------- ---------- ----------
(In thousands)
NET PREMIUMS EARNED
Standard lines ........................................... $ 54,357 $ 62,342 $ 61,047
Political subdivisions ................................... 5,253 3,436 2,747
Homeowners ............................................... 5,353 9 -
Surety bonds ............................................. 193 186 83
Other (1) ................................................ 548 212 150
---------- ---------- ----------
$ 65,704 $ 66,185 $ 64,027
========== ========== ==========
LOSSES AND LOSS ADJUSTMENT EXPENSES
Standard lines ........................................... $ 40,212 $ 37,122 $ 38,897
Political subdivisions ................................... 2,693 1,584 1,860
Homeowners ............................................... 2,515 (48) 34
Surety bonds ............................................. (152) 2,082 (43)
Other (1) ................................................ 205 653 192
---------- ---------- ----------
$ 45,473 $ 41,393 $ 40,940
========== ========== ==========
- --------------------------
<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 15. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
A summary of the unaudited quarterly operating results during 2007 and
2008 follows:
First Second Third Fourth Total
quarter quarter quarter quarter year
--------- --------- --------- --------- --------
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)
2008
- -----------------------------------------------------
Net premiums earned ................................ $ 17,510 $ 15,243 $ 15,691 $ 15,583 $64,027
Investment income, net ............................. 1,078 1,005 987 924 3,994
Realized investment gains, net ..................... - 4 91 - 95
Income (loss) before income taxes .................. 1,009 1,418 (738) (485) 1,204
Net income (loss) .................................. 616 850 (563) (378) 525
Net investment income included a decrease of a prejudgment interest
accrual on a favorable jury verdict in civil litigation regarding certain
surety bond claims of $4.5 million in the fourth quarter of 2007, based on
a final judgment entered by the court. See Note 11 for more information
related to this litigation.
* * * * * * *
PAGE F-28
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, 2007 and 2008, 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, 2008. 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. Tullius
Taylor Sartain & Sartain LLP audited the financial statements of Chandler
(U.S.A.), Inc. as of and for each of the two years in the period ended
December 31, 2007, and merged with Hogan & Slovacek, P.C. to form HoganTaylor
LLP effective January 7, 2009.
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
valuating 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, 2007 and 2008, and the results of its operations and
its cash flows for each of the three years in the period ended December 31,
2008 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, 2008 included in the accompanying Management's Report on Internal Control
Over Financial Reporting and, accordingly, we do not express an opinion
thereon.
/s/ HoganTaylor LLP
HoganTaylor LLP
Tulsa, Oklahoma
March 25, 2009
PAGE F-29
SCHEDULE I
CHANDLER (U.S.A.), INC. AND SUBSIDIARIES
SUMMARY OF INVESTMENTS - OTHER
THAN INVESTMENTS IN RELATED PARTIES
AS OF DECEMBER 31, 2008
(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 ............ $ 39,151 $ 41,500 $ 41,500
Corporate obligations ............................. 29,558 29,485 29,485
Public utilities .................................. 3,108 2,976 2,976
Obligations of states and political subdivisions .. 3,197 3,135 3,135
------------ ---------- ---------------
75,014 77,096 77,096
EQUITY SECURITIES AVAILABLE FOR SALE:
Corporate stock ................................... - 76 76
Short-term investments ............................ 5,853 5,865 5,865
------------ ---------- ---------------
Total investments ............................... $ 80,867 $ 83,037 $ 83,037
============ ========== ===============
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)
BALANCE SHEETS
(In thousands except share amounts)
DECEMBER 31,
---------------------
2007 2008
---------- ----------
ASSETS
Property and equipment, net ....................................... $ 1,021 $ 935
Amounts due from related parties .................................. 11,506 11,869
Other assets ...................................................... 2,561 1,678
Investment in subsidiaries, net ................................... 61,562 64,082
---------- ----------
Total assets ...................................................... $ 76,650 $ 78,564
========== ==========
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Accrued taxes and other payables ................................ $ 2,169 $ 2,009
Amounts due to subsidiaries ..................................... 3,278 3,591
Debentures ...................................................... 6,979 6,979
Junior subordinated debentures issued to affiliated trusts ...... 20,620 20,620
---------- ----------
Total liabilities ................................................. 33,046 33,199
---------- ----------
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 ............................................. (17,179) (16,654)
Accumulated other comprehensive income:
Unrealized gain on investments held by subsidiary and available
for sale, net of deferred income taxes ........................ 197 1,433
---------- ----------
Total shareholder's equity ........................................ 43,604 45,365
---------- ----------
Total liabilities and shareholder's equity ........................ $ 76,650 $ 78,564
========== ==========
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 OPERATIONS
(In thousands)
YEAR ENDED DECEMBER 31,
----------------------------------
2006 2007 2008
---------- ---------- ----------
Revenues
Investment income, net .................................. $ 4 $ 8 $ 1
Interest income, net from related parties ............... 792 941 647
Other income ............................................ 1,334 1,020 830
---------- ---------- ----------
Total revenues ........................................ 2,130 1,969 1,478
---------- ---------- ----------
Operating costs and expenses
General and administrative expenses ..................... 3,116 3,587 2,949
Interest expense ........................................ 2,649 2,665 2,544
---------- ---------- ----------
Total operating costs and expenses .................... 5,765 6,252 5,493
---------- ---------- ----------
Loss before income tax benefit ............................ (3,635) (4,283) (4,015)
Federal income tax benefit ................................ 1,606 1,430 1,205
---------- ---------- ----------
Net loss before equity in net
income of subsidiaries .................................. (2,029) (2,853) (2,810)
Equity in net income of subsidiaries ...................... 5,425 2,191 3,335
---------- ---------- ----------
Net income (loss) ......................................... $ 3,396 $ (662) $ 525
========== ========== ==========
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-32
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,
----------------------------------
2006 2007 2008
---------- ---------- ----------
Operating activities
Net income (loss) ......................................... $ 3,396 $ (662) $ 525
Add (deduct):
Adjustments to reconcile net income (loss) to cash
provided by (applied to) operating activities:
Net income of subsidiaries not distributed to parent ..... (5,425) (2,191) (3,335)
Net (gain) loss on sale of property and equipment ........ 8 (6) 10
Amortization and depreciation ............................ 218 243 265
Net change in non-cash balances relating to
operating activities:
Amounts due from subsidiaries ........................... 148 - -
Other assets ............................................ 809 1,059 827
Accrued taxes and other payables ........................ (162) 277 (160)
Amounts due to subsidiaries ............................. 1,306 1,973 313
---------- ---------- ----------
Cash provided by (applied to) operating activities ....... 298 693 (1,555)
---------- ---------- ----------
Investing activities
Cost of property and equipment purchased .................. (145) (420) (267)
Proceeds from sale of property and equipment .............. 45 49 135
---------- ---------- ----------
Cash applied to investing activities ..................... (100) (371) (132)
---------- ---------- ----------
Financing activities
Shareholder dividend from subsidiaries .................... - 1,600 2,050
Payments and loans from related parties ................... 1,747 2,164 2,639
Payments and loans to related parties ..................... (1,971) (4,086) (3,002)
---------- ---------- ----------
Cash provided by (applied to) financing activities ....... (224) (322) 1,687
---------- ---------- ----------
Decrease in cash ........................................... (26) - -
Cash at beginning of year .................................. 26 - -
---------- ---------- ----------
Cash at end of year ........................................ $ - $ - $ -
========== ========== ===========
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-33
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, 2006
Property and casualty ... $ 845 $ 83,253 $ 53,217 $ 7,663 $ 65,704 $ 10,572 $ 45,743 $ 11,666 $ 15,097 $ 64,789
Agency .................. - - - - - 21 - - 62 -
----------- --------- -------- ---------- --------- --------- ---------- ----------- --------- --------
Total ................... $ 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 $ 328 $ 41,393 $ 10,823 $ 13,805 $ 64,432
Agency .................. - - - - - 41 - 1,724 1,688 -
----------- --------- -------- ---------- --------- --------- ---------- ----------- --------- --------
Total ................... $ 1,118 $ 100,590 $ 46,389 $ 7,947 $ 66,185 $ 369 $ 41,393 $ 12,547 $ 15,493 $ 64,432
=========== ========= ======== ========== ========= ========= ========== =========== ========= ========
DECEMBER 31, 2008
Property and casualty ... $ 1,304 $ 101,459 $ 43,725 $ 7,820 $ 64,027 $ 3,967 $ 40,940 $ 10,573 $ 13,903 $ 62,312
Agency .................. - - - - - 27 - 1,775 1,790 -
----------- --------- -------- ---------- --------- --------- ---------- ----------- --------- --------
Total ................... $ 1,304 $ 101,459 $ 43,725 $ 7,820 $ 64,027 $ 3,994 $ 40,940 $ 12,348 $ 15,693 $ 62,312
=========== ========= ======== ========== ========= ========= ========== =========== ========= ========
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-34
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, 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%
============ ============ ============ ============ ============
Year ended December 31, 2008
Property and casualty ...... $ 90,871 $ (36,072) $ 7,513 $ 62,312 12.06%
============ ============ ============ ============ ============
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-35
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:
2006 ........................... $ 223 $ 73 $ (126) $ 170
================ ================ ================ ===============
2007 ........................... $ 170 $ 19 $ (55) $ 134
================ ================ ================ ===============
2008 ........................... $ 134 $ 30 $ (26) $ 138
================ ================ ================ ===============
Allowance for non-collection of reinsurance
recoverables on paid and unpaid losses:
2006 ........................... $ 174 $ 97 $ (141) $ 130
================ ================ ================ ===============
2007 ........................... $ 130 $ 356 $ (247) $ 239
================ ================ ================ ===============
2008 ........................... $ 239 $ 166 $ (174) $ 231
================ ================ ================ ===============
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-36
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, 2006
Property-casualty ................... $ - $ 43,941
=============== =================
Year ended December 31, 2007
Property-casualty ................... $ - $ 37,608
=============== =================
Year ended December 31, 2008
Property-casualty ................... $ - $ 37,738
=============== =================
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-37
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.