- -------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------------------
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
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SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2009
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
---
SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from to
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COMMISSION FILE NUMBER: 1-15135
CHANDLER (U.S.A.), INC.
(Exact name of registrant as specified in its charter)
OKLAHOMA 73-1325906
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1010 MANVEL AVENUE, CHANDLER, OKLAHOMA 74834
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (405) 258-0804
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. YES X NO
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Indicate by check mark whether the registrant has submitted electronically
and posted on its corporate Web site, if any, every Interactive Data File
required to be submitted and posted pursuant to Rule 405 of Regulation S-T
during the preceding 12 months (or for such shorter period that the registrant
was required to submit and post such files). YES NO
--- ---
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 Exchange Act). YES NO X
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The number of common shares, $1.00 par value, of the registrant outstanding
on October 31, 2009 was 2,484, which are owned by Chandler Insurance Company,
Ltd.
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Page i
CHANDLER (U.S.A.), INC.
INDEX
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PART I - FINANCIAL INFORMATION
- ------------------------------
ITEM 1. FINANCIAL STATEMENTS:
- --------------------------------
Consolidated Balance Sheets as of September 30, 2009 (unaudited)
and December 31, 2008 .................................................1
Consolidated Statements of Operations for the three months
ended September 30, 2009 and 2008 (unaudited) .........................2
Consolidated Statements of Operations for the nine months
ended September 30, 2009 and 2008 (unaudited) .........................3
Consolidated Statements of Comprehensive Income for the three
months ended September 30, 2009 and 2008 (unaudited) ..................4
Consolidated Statements of Comprehensive Income for the nine
months ended September 30, 2009 and 2008 (unaudited) ..................5
Consolidated Statements of Cash Flows for the nine months
ended September 30, 2009 and 2008 (unaudited) .........................6
Notes to Interim Consolidated Financial Statements (unaudited) ..............7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- --------------------------------------------------------------------------
RESULTS OF OPERATIONS ............................................15
---------------------
ITEM 4T. CONTROLS AND PROCEDURES ............................................21
- --------------------------------
PART II - OTHER INFORMATION
- ---------------------------
Item 1. Legal Proceedings ..............................................22
Item 1A. Risk Factors ...................................................22
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds ....22
Item 3. Defaults Upon Senior Securities ................................22
Item 4. Submission of Matters to a Vote of Security Holders ............22
Item 5. Other Information ..............................................22
Item 6. Exhibits .......................................................22
Signatures .................................................................23
PAGE 1
CHANDLER (U.S.A.), INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands except share amounts)
September 30, December 31,
2009 2008
------------ ------------
(Unaudited)
ASSETS
Investments
Fixed maturities available for sale, at fair value
Restricted (amortized cost $34,258 and $34,243 in 2009 and 2008, respectively) ...... $ 35,216 $ 35,397
Unrestricted (amortized cost $65,519 and $40,771 in 2009 and 2008, respectively) .... 67,223 41,699
Equity securities at fair value (cost $0 in 2009 and 2008) ........................... 186 76
Short-term investments at fair value (amortized cost $570 and $5,853
in 2009 and 2008, respectively) .................................................... 570 5,865
------------ ------------
Total investments ................................................................... 103,195 83,037
Cash and cash equivalents ($837 and $118 restricted in 2009 and 2008, respectively) ... 6,792 20,636
Accrued investment income ............................................................. 961 1,018
Premiums receivable, less allowance for non-collection of $139 and $138 at
2009 and 2008, respectively .......................................................... 21,458 26,405
Reinsurance recoverable on paid losses ................................................ 959 423
Reinsurance recoverable on unpaid losses, less allowance for
non-collection of $304 and $231 at 2009 and 2008, respectively ....................... 35,174 32,492
Reinsurance recoverable on unpaid losses from related parties ......................... 20,912 19,899
Prepaid reinsurance premiums .......................................................... 3,384 2,882
Prepaid reinsurance premiums to related parties ....................................... 11,570 12,203
Deferred policy acquisition costs ..................................................... 1,332 1,304
Property and equipment, net ........................................................... 7,286 7,849
Amounts due from related parties ...................................................... 12,301 11,869
State insurance licenses, net ......................................................... 3,745 3,745
Other assets .......................................................................... 10,335 10,885
------------ ------------
Total assets .......................................................................... $ 239,404 $ 234,647
============ ============
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Unpaid losses and loss adjustment expenses ........................................... $ 105,178 $ 101,459
Unearned premiums .................................................................... 42,122 43,725
Policyholder deposits ................................................................ 8,964 7,820
Accrued taxes and other payables ..................................................... 5,120 6,017
Premiums payable ..................................................................... 2,595 2,440
Premiums payable to related parties .................................................. 22 222
Senior debentures .................................................................... 6,979 6,979
Junior subordinated debentures issued to affiliated trusts ........................... 20,620 20,620
------------ ------------
Total liabilities ................................................................... 191,600 189,282
------------ ------------
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 .................................................................. (14,662) (16,654)
Accumulated other comprehensive income:
Unrealized gain on investments available for sale, net of deferred income taxes ...... 1,880 1,433
------------ ------------
Total shareholder's equity .......................................................... 47,804 45,365
------------ ------------
Total liabilities and shareholder's equity ............................................ $ 239,404 $ 234,647
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 2
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Amounts in thousands)
Three months ended September 30,
--------------------------------
2009 2008
------------- -------------
Premiums and other revenues
Direct premiums written and assumed ........................... $ 20,396 $ 24,160
Reinsurance premiums ceded .................................... (2,682) (2,441)
Reinsurance premiums ceded to related parties ................. (5,293) (6,533)
------------- -------------
Net premiums written and assumed ............................ 12,421 15,186
Decrease in unearned premiums ................................. 836 505
------------- -------------
Net premiums earned ......................................... 13,257 15,691
Investment income, net .......................................... 838 828
Interest income, net from related parties ....................... 111 159
Realized investment gains, net .................................. 194 91
Other income .................................................... 825 731
------------- -------------
Total premiums and other revenues ............................. 15,225 17,500
------------- -------------
Operating costs and expenses
Losses and loss adjustment expenses, net of amounts
ceded to related parties of $3,078 and $3,665 in
2009 and 2008, respectively ................................. 8,039 11,352
Policy acquisition costs, net of ceding commissions
received from related parties of $2,012 and $2,484 in
2009 and 2008, respectively ................................. 2,941 3,097
General and administrative expenses ........................... 2,699 3,161
Interest expense .............................................. 585 628
------------- -------------
Total operating costs and expenses .......................... 14,264 18,238
------------- -------------
Income (loss) before income taxes ............................... 961 (738)
Federal income tax benefit (provision) .......................... (365) 175
------------- -------------
Net income (loss) ............................................. $ 596 $ (563)
============= =============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 3
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Amounts in thousands)
Nine months ended September 30,
--------------------------------
2009 2008
------------- -------------
Premiums and other revenues
Direct premiums written and assumed ........................... $ 66,284 $ 74,554
Reinsurance premiums ceded .................................... (8,060) (7,260)
Reinsurance premiums ceded to related parties ................. (17,361) (20,136)
------------- -------------
Net premiums written and assumed ............................ 40,863 47,158
Decrease in unearned premiums ................................. 1,472 1,286
------------- -------------
Net premiums earned ......................................... 42,335 48,444
Investment income, net .......................................... 2,379 2,565
Interest income, net from related parties ....................... 326 505
Realized investment gains, net .................................. 1,383 95
Other income .................................................... 1,600 1,559
------------- -------------
Total premiums and other revenues ............................. 48,023 53,168
------------- -------------
Operating costs and expenses
Losses and loss adjustment expenses, net of amounts
ceded to related parties of $11,303 and $11,296 in
2009 and 2008, respectively ................................. 25,801 30,668
Policy acquisition costs, net of ceding commissions
received from related parties of $6,600 and $7,656 in
2009 and 2008, respectively ................................. 8,735 9,464
General and administrative expenses ........................... 8,523 9,440
Interest expense .............................................. 1,778 1,907
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Total operating costs and expenses .......................... 44,837 51,479
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Income before income taxes ...................................... 3,186 1,689
Federal income tax provision .................................... (1,194) (786)
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Net income .................................................... $ 1,992 $ 903
============= =============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 4
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Amounts in thousands)
Three months ended September 30,
--------------------------------
2009 2008
------------- ------------
Net income (loss) ............................................. $ 596 $ (563)
------------- ------------
Other comprehensive income (loss), before income tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period ... 2,497 (401)
Less: Reclassification adjustment for gains included in
net income (loss) ....................................... (194) (91)
------------- ------------
Other comprehensive income (loss), before income tax .......... 2,303 (492)
Income tax (provision) benefit related to items of other
comprehensive income (loss) ................................. (783) 167
------------- ------------
Other comprehensive income (loss), net of income tax .......... 1,520 (325)
------------- ------------
Comprehensive income (loss) ................................... $ 2,116 $ (888)
============= ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 5
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Amounts in thousands)
Nine months ended September 30,
--------------------------------
2009 2008
------------- ------------
Net income .................................................... $ 1,992 $ 903
------------- ------------
Other comprehensive income (loss), before income tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period ... 2,061 (712)
Less: Reclassification adjustment for gains included in
net income .............................................. (1,383) (95)
------------- ------------
Other comprehensive income (loss), before income tax .......... 678 (807)
Income tax benefit (provision) related to items of other
comprehensive income (loss) ................................. (231) 274
------------- ------------
Other comprehensive income (loss), net of income tax .......... 447 (533)
------------- ------------
Comprehensive income .......................................... $ 2,439 $ 370
============= ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 6
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Amounts in thousands)
Nine months ended September 30,
--------------------------------
2009 2008
------------ ------------
OPERATING ACTIVITIES
Net income .................................................................. $ 1,992 $ 903
Add (deduct):
Adjustments to reconcile net income to cash provided by
operating activities:
Realized investment gains, net .......................................... (1,383) (95)
Net losses on sale of property and equipment ............................ 29 -
Amortization and depreciation ........................................... 1,371 1,151
Provision for non-collection of premiums ................................ 65 15
Provision for non-collection of reinsurance recoverables ................ 160 155
Provision for impairment of investment .................................. 30 -
Net change in non-cash balances relating to operating activities:
Accrued investment income ............................................. 57 (46)
Premiums receivable ................................................... 4,882 495
Reinsurance recoverable on paid losses ................................ (623) (1,575)
Reinsurance recoverable on paid losses from related parties ........... - (687)
Reinsurance recoverable on unpaid losses .............................. (2,755) 790
Reinsurance recoverable on unpaid losses from related parties ......... (1,013) (882)
Prepaid reinsurance premiums .......................................... (502) 61
Prepaid reinsurance premiums to related parties ....................... 633 548
Deferred policy acquisition costs ..................................... (28) (24)
Other assets .......................................................... 246 159
Unpaid losses and loss adjustment expenses ............................ 3,719 3,213
Unearned premiums ..................................................... (1,603) (1,895)
Policyholder deposits ................................................. 1,144 715
Accrued taxes and other payables ...................................... (897) (760)
Premiums payable ...................................................... 155 (192)
Premiums payable to related parties ................................... (200) (198)
------------ ------------
Cash provided by operating activities ................................... 5,479 1,851
------------ ------------
INVESTING ACTIVITIES
Short-term investments:
Purchases ............................................................... (380) (3,594)
Maturities .............................................................. 5,660 1,330
Unrestricted fixed maturities available for sale:
Purchases ............................................................... (58,249) (34,192)
Sales ................................................................... 25,984 6,417
Maturities .............................................................. 8,215 16,182
Equity securities available for sale:
Purchases ............................................................... - (266)
Sales ................................................................... - 270
Cost of property and equipment purchased .................................. (140) (570)
Proceeds from sale of property and equipment .............................. 19 129
------------ ------------
Cash applied to investing activities .................................... (18,891) (14,294)
------------ ------------
FINANCING ACTIVITIES
Payments and loans from related parties ................................... 1,912 2,146
Payments and loans to related parties ..................................... (2,344) (2,866)
Payments on bank loan ..................................................... - -
------------ ------------
Cash applied to financing activities .................................... (432) (720)
------------ ------------
Decrease in cash and cash equivalents during the period ..................... (13,844) (13,163)
Cash and cash equivalents at beginning of period ............................ 20,636 32,956
------------ ------------
Cash and cash equivalents at end of period .................................. $ 6,792 $ 19,793
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 7
CHANDLER (U.S.A.), INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008
(Unaudited)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Chandler
(U.S.A.), Inc. ("Chandler USA") have been prepared in accordance with
generally accepted accounting principles for interim financial information
and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. They
do not include all information and footnotes required by generally accepted
accounting principles for complete financial statements. However, except as
disclosed herein, there have been no material changes in the information
included in Chandler USA's Annual Report on Form 10-K for the year ended
December 31, 2008. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation
have been included. The results of operations for the interim periods ended
September 30, 2009 are not necessarily indicative of the results that may be
expected for the year. Chandler USA has evaluated subsequent events for
potential recognition or disclosure through November 9, 2009, the issuance
date of Chandler USA's consolidated financial statements.
The consolidated financial statements include the accounts of Chandler
USA and all wholly owned subsidiaries that meet consolidation requirements
including National American Insurance Company ("NAICO") and Chandler Insurance
Managers, Inc. ("CIMI").
NOTE 2. SEGMENT INFORMATION
Chandler USA has two reportable operating segments: property and casualty
insurance and agency. The segments are managed separately due to the
differences in the nature of the insurance products and services sold. The
following table presents a summary of Chandler USA's operating segments for
the periods indicated:
PROPERTY
AND
CASUALTY INTERSEGMENT REPORTED
INSURANCE AGENCY ELIMINATIONS BALANCES
------------ ------------ ------------ ------------
(In thousands)
THREE MONTHS ENDED SEPTEMBER 30, 2009
Revenues from external customers (1) ........... $ 13,338 $ 744 $ - $ 14,082
Intersegment revenues .......................... 40 534 (574) -
Segment profit before income taxes (2) ......... 531 430 - 961
THREE MONTHS ENDED SEPTEMBER 30, 2008
Revenues from external customers (1) ........... $ 15,848 $ 574 $ - $ 16,422
Intersegment revenues .......................... 21 805 (826) -
Segment profit (loss) before income taxes (2) .. (1,282) 544 - (738)
NINE MONTHS ENDED SEPTEMBER 30, 2009
Revenues from external customers (1) ........... $ 42,671 $ 1,264 $ - $ 43,935
Intersegment revenues .......................... 111 1,940 (2,051) -
Segment profit before income taxes (2) ......... 2,572 614 - 3,186
Segment assets ................................. 236,972 9,940 (7,508) 239,404
NINE MONTHS ENDED SEPTEMBER 30, 2008
Revenues from external customers (1) ........... $ 48,839 $ 1,164 $ - $ 50,003
Intersegment revenues .......................... 44 2,525 (2,569) -
Segment profit before income taxes (2) ......... 477 1,212 - 1,689
Segment assets ................................. 233,081 9,871 (7,332) 235,620
- ---------------------------------------------------
<FN>
(1) Consists of net premiums earned and other income.
(2) Includes net realized investment gains.
PAGE 8
Net premiums earned and losses and loss adjustment expenses within the
property and casualty insurance segment can be identified to Chandler USA
designated insurance programs and to each line of insurance. Chandler USA's
chief operating decision makers review net premiums earned and losses and
loss adjustment expenses in assessing the performance of the insurance
programs and lines of business. 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 programs or lines of insurance, including assets,
interest income, and investment gains or losses, allocated to each insurance
program or line of insurance. Chandler USA does not consider its insurance
programs or lines of insurance 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 by
insurance program and line of insurance for the property and casualty
insurance segment.
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- --------------------------------
2009 2008 2009 2008
------------ ------------ ------------ ------------
(In thousands)
INSURANCE PROGRAM:
- -----------------------------------------
NET PREMIUMS EARNED
Standard lines ........................ $ 12,828 $ 14,943 $ 40,433 $ 46,169
Political subdivisions ................ 373 694 1,654 2,092
Other ................................. 56 54 248 183
------------ ------------ ------------ ------------
TOTAL ................................. $ 13,257 $ 15,691 $ 42,335 $ 48,444
============ ============ ============ ============
LOSSES AND LOSS ADJUSTMENT EXPENSES
Standard lines ........................ $ 7,678 $ 10,703 $ 23,647 $ 28,881
Political subdivisions ................ 200 626 1,370 1,481
Other ................................. 161 23 784 306
------------ ------------ ------------ ------------
TOTAL ................................. $ 8,039 $ 11,352 $ 25,801 $ 30,668
============ ============ ============ ============
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- --------------------------------
2009 2008 2009 2008
------------ ------------ ------------ ------------
(In thousands)
LINES OF INSURANCE:
- -----------------------------------------
NET PREMIUMS EARNED
Automobile liability................... $ 3,135 $ 5,064 $ 12,288 $ 16,880
Workers compensation .................. 5,531 4,945 15,813 15,006
Other liability ....................... 3,314 4,110 9,936 12,507
Automobile physical damage ............ 1,138 1,549 4,073 4,039
Other ................................. 139 23 225 12
------------ ------------ ------------ ------------
TOTAL ................................. $ 13,257 $ 15,691 $ 42,335 $ 48,444
============ ============ ============ ============
LOSSES AND LOSS ADJUSTMENT EXPENSES
Automobile liability .................. $ 3,008 $ 4,413 $ 7,881 $ 12,369
Workers compensation .................. 3,132 4,050 11,847 10,604
Other liability ....................... 1,227 1,863 4,104 4,489
Automobile physical damage ............ 525 1,111 1,915 3,086
Other ................................. 147 (85) 54 120
------------ ------------ ------------ ------------
TOTAL ................................. $ 8,039 $ 11,352 $ 25,801 $ 30,668
============ ============ ============ ============
PAGE 9
NOTE 3. COMMITMENTS AND CONTINGENCIES
During March 2001, Chandler USA entered into a $3.8 million sale and
leaseback transaction for certain owned equipment for three years. During
March 2004, the lease was extended for three years and during March 2007, the
lease was extended for an additional three years with monthly rental
installments equal to the sum of (i) $13,834 plus (ii) interest on the unpaid
lease balance at 1% over JP Morgan Chase Bank prime which was 4.25% at
September 30, 2009. Chandler USA has the option to repurchase the equipment
at the end of the lease for approximately $1.9 million (the "Balloon
Payment"), or may elect to have the lessor sell the equipment. If the
election to sell the equipment is made, Chandler USA would retain any proceeds
exceeding the Balloon Payment. If the proceeds were less than the Balloon
Payment, Chandler USA would be required to pay the difference between the
proceeds and the Balloon Payment, not to exceed approximately $1.5 million.
Chandler USA has guaranteed the obligations of Chandler Capital Trust I
and Chandler Capital Trust II (the "Capital Trusts") with respect to the trust
preferred securities they have outstanding. The Capital Trusts distribute the
interest received from Chandler USA on the junior subordinated debentures to
the holders of the trust preferred securities to fulfill their obligations
with respect to such securities. The Capital Trusts are wholly owned non-
consolidated subsidiaries of Chandler USA. 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 4. LITIGATION
In October 1999, NAICO provided surety bonds for Gulsby Engineering, Inc.
("Gulsby") in connection with contracts between Gulf Liquids New River
Project, LLC ("Gulf Liquids") and Gulsby for the construction of two gas
processing plants in Louisiana. During 2001, Gulsby became unable to pay
various vendors resulting in payments to vendors by NAICO totaling $20,182,499.
In August 2001, NAICO filed suit in federal court in Louisiana alleging that
Gulf Liquids had breached its obligations under the bonds by materially
altering certain contracts and that, as a result, NAICO was exonerated on the
bonds and should recover the amounts paid to vendors. In the fall of 2001,
Gulsby and Bay Limited, another contractor with whom Gulsby had entered into
a joint venture for the construction of other gas processing plants for Gulf
Liquids, filed lawsuits relating to those plants in Houston, Texas. Gulf
Liquids filed original actions and counterclaims. NAICO intervened in the
Texas lawsuits and, in addition, sued Williams Energy Marketing and Trading
(which later became Williams Power Company, Inc.) ("Williams") alleging fraud,
breach of contract, tortious interference with contractual relations,
conspiracy and alter ego. These claims were asserted against both Gulf Liquids
and Williams. Gulf Liquids asserted counterclaims alleging breach of contract
against NAICO and requesting contractual and statutory damages ranging from
$40 million to $80 million. The cases were consolidated for trial in the 215th
Judicial District Court in Harris County, Texas.
The trial in the Harris County cases began in late April 2006, and
concluded August 1, 2006. The jury found in favor of NAICO and Gulsby, Bay
Limited and the joint venture between Gulsby and Bay Limited ("Gulsby-Bay
Plant Partners") on all counts and fixed damages against Gulf Liquids and
Williams totaling $402,568,089.53. The damages determined by the jury included
a total of $325 million in punitive damages. Among other findings, the jury
found:
1. Williams tortiously interfered with NAICO's contractual relationship with
Gulsby and Gulf Liquids; and
2. Williams fraudulently induced NAICO to issue the surety bonds; and
3. Williams defrauded NAICO after the bonds were issued; and
4. Williams' actions were malicious; and
5. Gulf Liquids fraudulently induced NAICO to issue the surety bonds; and
6. Gulf Liquids breached its obligations to NAICO under the bonds; and
7. Williams is responsible for the claims against Gulf Liquids because Gulf
Liquids is the alter ego of Williams; and
8. There were material alterations (cardinal changes) to the contracts
NAICO bonded.
The amounts the jury found owing to NAICO included $20,182,499 in actual
damages, against both Gulf Liquids and Williams, $20 million in punitive
damages against Gulf Liquids, and $50 million in punitive damages against
Williams. The verdicts in favor of Gulsby included $20,941,436 in actual
damages against both Gulf Liquids and Williams, $25 million in punitive
damages against Gulf Liquids and $60 million in punitive damages against
Williams.
NAICO is subrogated to any recovery by Gulsby to the extent of NAICO's
losses on the bonds including loss adjustment expenses with interest from the
date the losses and loss expenses were paid.
PAGE 10
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.
On January 28, 2008, the court entered a final judgment denying Gulf
Liquid's claims against NAICO and Gulsby, denying all of NAICO's claims
against Gulf Liquids and Williams, and entering judgment for Gulsby against
Gulf Liquids for $15,651,927 plus interest at 7.25% compounded annually from
January 28, 2008 until paid. The court also ordered Gulf Liquids to pay
Gulsby's taxable court costs, estimated at $100,000. Gulf Liquids has
appealed the judgment entered in favor of Gulsby and the denial of its claims
against NAICO and Gulsby. NAICO has appealed the trial court's denial of its
claims against Gulf Liquids and Williams and seeks entry of judgment upon the
jury verdicts for the amounts the jury found should be awarded to NAICO.
Gulsby has also appealed the trial court's final judgment, contending that
judgment should be entered in its favor against Gulf Liquids and Williams in
accordance with the jury verdicts. The recoverable amounts deducted from
Chandler USA's net liability for losses and loss adjustment expenses related
to this litigation were approximately $10.1 million at September 30, 2009 and
December 31, 2008.
NOTE 5. NEW ACCOUNTING STANDARDS
Chandler USA has reviewed the recently issued accounting pronouncements
and concluded that the following new accounting standards and accounting
standard updates are applicable to Chandler USA.
In June 2009, the Financial Accounting Standards Board ("FASB") issued
guidance on "The FASB Accounting Standards Codification and the Hierarchy of
Generally Accepted Accounting Principles," and established the FASB Accounting
Standards Codification ("Codification") as the single source of authoritative
accounting principles in the preparation of financial statements in conformity
with GAAP. Rules and interpretive releases of the Securities and Exchange
Commission ("SEC") under authority of federal securities laws are also sources
of authoritative GAAP for SEC registrants. The FASB will no longer issue new
standards in the form of Statements, FASB Staff Positions, or Emerging Issues
Task Force Abstracts; instead the FASB will issue Accounting Standards
Updates. Accounting Standards Updates will not be authoritative in their own
right as they will only serve to update the Codification. Chandler USA has
adopted the Codification as of September 30, 2009. The adoption of the
Codification did not have any impact on its consolidated financial statements.
In March 2008, the FASB issued new guidance on 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, and (c) how derivative instruments and related hedged items
affect an entity's financial position, financial performance and cash flows.
Chandler USA has adopted this new guidance as of January 1, 2009. The
adoption of this new guidance did not have any impact on its consolidated
financial statements.
In April 2009, the FASB issued new guidance related to the disclosures
regarding fair value of financial instruments. The new guidance expands the
existing disclosures regarding fair value of financial instruments that is
required in annual reports to interim periods. The required disclosures are
effective for interim reporting periods ending after June 15, 2009. Chandler
USA adopted this new guidance as of June 30, 2009. The adoption of this new
guidance did not have any impact on its consolidated financial statements.
See Note 7 for the required disclosures.
In April 2009, the FASB issued new guidance for estimating fair value
when the volume and level of activity for the asset or liability have
significantly decreased. Chandler USA has adopted this new guidance as of
June 30, 2009. The adoption of this new guidance did not have any impact on
its consolidated financial statements.
In April 2009, the FASB issued new guidance for accounting for other-
than-temporary impairments for debt securities to make the guidance more
operational and to improve the presentation and disclosure of other-than-
temporary impairments on debt and equity securities in the financial
statements. Chandler USA has adopted this new guidance as of June 30, 2009.
The adoption of this new guidance did not have any impact on its consolidated
financial statements. See Note 6 for the required disclosures.
PAGE 11
In May 2009, the FASB issued new guidance for accounting for subsequent
events. This new guidance establishes general standards of accounting for
and disclosure of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued. This new
guidance defines the period after the balance sheet date during which
management of a reporting entity should evaluate events or transactions that
may occur for potential recognition or disclosure in the financial
statements, the circumstances under which an entity should recognize events
or transactions occurring after the balance sheet date in its financial
statements and the disclosures that an entity should make about events or
transactions that occurred after the balance sheet date. Chandler USA has
adopted this new guidance as of June 30, 2009. The adoption of this new
guidance did not have any impact on its consolidated financial statements.
In June 2009, the FASB issued new guidance on the accounting for transfers
of financial assets. The new guidance requires additional disclosures for
transfers of financial assets, including securitization transactions, and any
continuing exposure to the risks related to transferred financial assets.
There is no longer a concept of a qualifying special-purpose entity, and the
requirements for derecognizing financial assets have changed. This new
guidance is effective for financial statements issued for fiscal years and
interim periods beginning after November 15, 2009, with early application
prohibited. Chandler USA is currently evaluating the impact that this new
guidance will have, if any, on its consolidated financial statements.
In June 2009, the FASB issued new guidance on the accounting for variable
interest entities. The new guidance requires an enterprise to perform an
analysis to determine whether the enterprise's variable interest or interests
give it a controlling financial interest in a variable interest entity; to
require ongoing reassessments of whether an enterprise is the primary
beneficiary of a variable interest entity; to eliminate the quantitative
approach previously required for determining the primary beneficiary of a
variable interest entity; to add an additional reconsideration event for
determining whether an entity is a variable interest entity when any changes
in facts and circumstances occur such that holders of the equity investment
at risk, as a group, lose the power from voting rights or similar rights of
those investments to direct the activities of the entity that most
significantly impact the entity's economic performance; and to require
enhanced disclosures that will provide users of financial statements with
more transparent information about an enterprise's involvement in a variable
interest entity. This new guidance is effective for financial statements
issued for fiscal years and interim periods beginning after November 15, 2009,
with early application prohibited. Chandler USA is currently evaluating the
impact that this new guidance will have, if any, on its consolidated financial
statements.
In August 2009, the FASB issued new guidance to provide clarification on
measuring liabilities at fair value when a quoted price in an active market is
not available. This new guidance became effective for Chandler USA on October
1, 2009. Chandler USA is currently evaluating the impact that this new
guidance will have, if any, on its consolidated financial statements.
NOTE 6. INVESTMENTS AND INVESTMENT INCOME
Net investment income and realized investment gains are summarized in the
following table. These amounts are net of investment expenses.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
2009 2008 2009 2008
-------- -------- -------- --------
(In thousands)
Interest on fixed-maturity investments ................... $ 883 $ 774 $ 2,457 $ 2,196
Interest on short-term investments and cash equivalents .. 10 121 106 578
Investment expenses ...................................... (55) (67) (184) (209)
-------- -------- -------- --------
Investment income, net ................................. 838 828 2,379 2,565
Realized gains, net - fixed maturity investments ......... 194 91 1,383 91
Realized gains, net - equity securities .................. - - - 4
-------- -------- -------- --------
Realized investment gains, net ......................... 194 91 1,383 95
-------- -------- -------- --------
$ 1,032 $ 919 $ 3,762 $ 2,660
======== ======== ======== ========
Investment expenses included $19,000 and $73,000 in the third quarter and
first nine months of 2009, and $30,000 and $100,000 in the third quarter and
first nine months of 2008, respectively, in expense to subsidize a premium
finance program for certain insureds of NAICO with an unaffiliated premium
finance company.
PAGE 12
The amortized cost of fixed maturities or cost of equity securities,
gross unrealized gains or losses, fair value and carrying value of investments
are as follows:
GROSS GROSS
UNREALIZED UNREALIZED FAIR CARRYING
SEPTEMBER 30, 2009 COST GAINS LOSSES VALUE VALUE
- --------------------------------------------------- ---------- ---------- ---------- ---------- ----------
FIXED MATURITIES AVAILABLE FOR SALE: (In thousands)
U.S. Treasury securities and obligations
of U.S. government corporations
and agencies ................................... $ 37,007 $ 962 $ (30) $ 37,939 $ 37,939
Corporate obligations ............................. 34,446 912 (62) 35,296 35,296
Public utilities .................................. 2,056 67 - 2,123 2,123
Obligations of states and political subdivisions .. 26,268 817 (4) 27,081 27,081
---------- ---------- ---------- ---------- ----------
$ 99,777 $ 2,758 $ (96) $ 102,439 $ 102,439
========== ========== ========== ========== ==========
EQUITY SECURITIES:
Corporate stock ................................... $ - $ 186 $ - $ 186 $ 186
========== ========== ========== ========== ==========
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
========== ========== ========== ========== ==========
Chandler USA held investments in fixed maturities issued by General
Electric Capital Corporation with a fair value of $4.7 million or 9.8% of
shareholder's equity at September 30, 2009, and $4.6 million or 10.1% of
shareholder's equity at December 31, 2008. Other than investments in bonds
and notes of the U.S. Government and U.S. Government agencies and authorities,
Chandler USA did not hold any other fixed maturity investments that exceeded
10% of shareholder's equity at September 30, 2009 or December 31, 2008.
The fair value of Chandler USA's investments with continuous gross
unrealized losses at September 30, 2009 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 .......... $ 3,247 $ (29) $ - $ - $ 3,247 $ (29)
Corporate securities ................. 714 (7) 1,001 (56) 1,715 (63)
Public utilities ..................... - - - - - -
Obligations of states and political
subdivisions ....................... 1,354 (4) - - 1,354 (4)
----------- ---------- ----------- ---------- ----------- ----------
$ 5,315 $ (40) $ 1,001 $ (56) $ 6,316 $ (96)
=========== ========== =========== ========== =========== ==========
PAGE 13
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 September 30, 2009.
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 September 30, 2009 are shown below:
AVAILABLE FOR SALE
------------------------
AMORTIZED
COST FAIR VALUE
------------ ----------
(In thousands)
Due in one year or less .......................... $ 3,258 $ 3,281
Due after one year through five years ............ 50,683 52,252
Due after five years through ten years ........... 39,342 40,125
Due after ten years .............................. 6,494 6,781
------------ ----------
$ 99,777 $ 102,439
============ ==========
Realized gains and losses from sales of investments are shown below:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
2009 2008 2009 2008
-------- -------- -------- --------
(In thousands)
FIXED MATURITIES:
Gross realized gains ........... $ 194 $ 148 $ 1,383 $ 148
Gross realized losses .......... - (57) - (57)
-------- -------- -------- --------
Total net realized gains ..... $ 194 $ 91 $ 1,383 $ 91
======== ======== ======== ========
EQUITY SECURITIES:
Gross realized gains ........... $ - $ - $ - $ 4
Gross realized losses .......... - - - -
-------- -------- -------- --------
Total net realized gains ..... $ - $ - $ - $ 4
======== ======== ======== ========
NAICO is required to deposit cash and securities with regulatory agencies
in which it is licensed as a condition of conducting operations in the state.
In addition, NAICO has deposited cash and securities into a trust account as
collateral for a reinsurance agreement in which NAICO is the assuming
reinsurer. During the third quarter of 2009, NAICO established a letter of
credit in the amount of $500,000 and pledged cash and investments in this
amount. The letter of credit secures reserves assumed under a quota share
reinsurance agreement. At September 30, 2009, the total amount of cash and
securities restricted as a result of these arrangements was $36.1 million
which was an increase of $538,000 from December 31, 2008.
PAGE 14
NOTE 7. FAIR VALUE MEASUREMENTS
Fair value is defined 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. The quality and reliability of
the information used to determine fair values is prioritized 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 as follows:
Level 1 - Quoted prices (unadjusted) in active markets for identical
assets or liabilities that the reporting entity has the ability to
access at the measurement date.
Level 2 - Observable inputs other than quoted prices included within
Level 1 for the asset or liability, either directly or indirectly. If
an asset or liability has a specified term, a Level 2 input must be
observable for substantially the full term of the asset or liability.
Level 3 - Unobservable inputs for the asset or liability.
The following table presents information about Chandler USA's assets
measured at fair value on a recurring basis as of September 30, 2009, and
indicates the fair value hierarchy of the valuation techniques utilized to
determine such values. Substantially all of the prices of fixed maturities,
equity securities and short-term investments that are valued as Level 1 or
Level 2 in the fair value hierarchy are received from independent pricing
services utilized by our investment custodians. No liabilities were
measured at fair value at September 30, 2009.
FAIR VALUE MEASUREMENTS AT SEPTEMBER 30, 2009
----------------------------------------------------------------------
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 ... $ - $ 102,439 $ - $ 102,439
Equity securities available for sale .. - - 186 186
Short-term investments ................ - 570 - 570
---------------- ---------------- ---------------- ----------------
Total ............................... $ - $ 103,009 $ 186 $ 103,195
================ ================ ================ ================
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 $380,000 at September 30, 2009,
or 0.4% of total Level 2 assets.
At September 30, 2009, Chandler USA's equity securities which were
measured at fair value using Level 3 inputs consisted of common stock received
in connection with an unaffiliated entity's conversion to a for-profit
corporation. The fair value of this stock was based upon an analytically
determined valuation from an independent rating organization. The following
table presents additional information about assets measured at fair value
using Level 3 inputs for the three and nine month periods ended September
30, 2009.
THREE MONTHS NINE MONTHS
FAIR VALUE MEASUREMENTS USING SIGNIFICANT ENDED ENDED
UNOBSERVABLE INPUTS (LEVEL 3) SEPTEMBER 30, 2009 SEPTEMBER 30, 2009
------------------------------------------------- ------------------ ------------------
(In thousands)
Beginning balance ............................. $ 76 $ 76
Total realized and unrealized gains (losses):
Included in earnings ...................... - -
Included in other comprehensive income .... 110 110
Purchases, issuances and settlements ........ - -
Transfers in and/or out of Level 3 .......... - -
------------------ ------------------
Ending balance ................................ $ 186 $ 186
================== ==================
PAGE 15
NOTE 8. FAIR VALUE DISCLOSURES OF FINANCIAL INSTRUMENTS
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
September 30, 2009 and December 31, 2008. The estimated fair values of
Chandler USA's fixed-maturity and equity security investments are disclosed at
Note 6. The fair value of Chandler USA's senior debentures was estimated to
be $5.6 million as of September 30, 2009 and December 31, 2008, based on the
latest reported trade. Chandler USA's senior debentures have not historically
traded regularly, and settlement at the reported fair value may not be
possible. The senior debentures are redeemable by Chandler USA on or after
July 15, 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 September 30, 2009 was 4.61%. The fair
value of Chandler USA's junior subordinated debentures was estimated to be
$22.9 million and $24.6 million at September 30, 2009 and December 31, 2008,
respectively.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
Some of the statements made in this Form 10-Q report, as well as
statements made by Chandler (U.S.A.), Inc. ("Chandler USA") in periodic press
releases and oral statements made by Chandler USA's officials constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements involve known
and unknown risks, uncertainties and other factors that may cause the actual
results, performance or achievements of Chandler USA to be materially different
from any future results, performance or achievements expressed or implied by
the forward-looking statements. Such factors include, among other things,
(i) general economic and business conditions; (ii) interest rate changes;
(iii) competition and regulatory environment in which Chandler USA and its
subsidiaries operate, including the ability to implement price increases;
(iv) claims frequency; (v) claims severity; (vi) catastrophic events of
unanticipated frequency or severity; (vii) the number of new and renewal
policy applications submitted to National American Insurance Company ("NAICO")
by its agents; (viii) the ability of NAICO to obtain adequate reinsurance in
amounts and at rates that will not adversely affect its competitive position;
(ix) the ability of NAICO to collect reinsurance recoverables; (x) the ability
of NAICO to maintain favorable insurance company ratings; and (xi) various
other factors including ongoing litigation matters.
PAGE 16
RESULTS OF OPERATIONS
PREMIUMS EARNED
The following table sets forth premiums earned on a gross basis (before
reductions for premiums ceded to reinsurers) and on a net basis (after such
reductions) for each insurance program as well as each line of insurance for
the periods indicated:
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
--------------------------- ---------------------------
THREE MONTHS ENDED SEPTEMBER 30, 2009 2008 2009 2008
---------------------------------- ------------ ------------ ------------ ------------
(In thousands)
INSURANCE PROGRAMS:
Standard lines ................... $ 20,767 $ 23,787 $ 12,828 $ 14,943
Political subdivisions ........... 573 1,058 373 694
Other ............................ 64 62 56 54
------------ ------------ ------------ ------------
TOTAL ............................ $ 21,404 $ 24,907 $ 13,257 $ 15,691
============ ============ ============ ============
LINES OF INSURANCE:
Automobile liability ............. $ 4,585 $ 7,385 $ 3,135 $ 5,064
Workers compensation ............. 8,464 7,785 5,531 4,945
Other liability .................. 6,414 7,436 3,314 4,110
Automobile physical damage ....... 1,694 2,269 1,138 1,549
Other ............................ 247 32 139 23
------------ ------------ ------------ ------------
TOTAL ............................ $ 21,404 $ 24,907 $ 13,257 $ 15,691
============ ============ ============ ============
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
--------------------------- ---------------------------
NINE MONTHS ENDED SEPTEMBER 30, 2009 2008 2009 2008
---------------------------------- ------------ ------------ ------------ ------------
(In thousands)
INSURANCE PROGRAMS:
Standard lines ................... $ 65,081 $ 73,046 $ 40,433 $ 46,169
Political subdivisions ........... 2,536 3,190 1,654 2,092
Other ............................ 270 213 248 183
------------ ------------ ------------ ------------
TOTAL ............................ $ 67,887 $ 76,449 $ 42,335 $ 48,444
============ ============ ============ ============
LINES OF INSURANCE:
Automobile liability ............. $ 17,866 $ 24,472 $ 12,288 $ 16,880
Workers compensation ............. 24,365 23,302 15,813 15,006
Other liability .................. 19,226 22,735 9,936 12,507
Automobile physical damage ....... 6,043 5,925 4,073 4,039
Other ............................ 387 15 225 12
------------ ------------ ------------ ------------
TOTAL ............................ $ 67,887 $ 76,449 $ 42,335 $ 48,444
============ ============ ============ ============
Gross premiums earned decreased $3.5 million or 14% and $8.6 million or
11% in the third quarter and first nine months of 2009, respectively, compared
to the 2008 periods. Net premiums earned decreased $2.4 million or 16% and
$6.1 million or 13% for the third quarter and first nine months of 2009,
respectively.
Gross premiums earned in the standard lines program decreased $3.0 million
or 13% and $8.0 million or 11% in the third quarter and first nine months of
2009, respectively, compared to the 2008 periods. Gross premiums earned from
trucking accounts in this program decreased $1.9 and $5.3 million in the third
quarter and first nine months of 2009, respectively. Gross premiums earned in
this program for other liability decreased $822,000 and $3.3 million in the
third quarter and first nine months of 2009, respectively, and gross premiums
earned in this program for automobile liability decreased $2.6 million and $6.3
million in the third quarter and first nine months of 2009. These decreases
were partially offset by an increase in workers compensation premiums. Net
premiums earned decreased $2.1 million or 14% and $5.7 million or 12% in the
third quarter and first nine months of 2009, respectively.
PAGE 17
Gross premiums earned in the political subdivisions program decreased
$485,000 or 46% and $654,000 or 21% in the third quarter and first nine months
of 2009, respectively, compared to the 2008 periods. Net premiums earned in
this program decreased $321,000 or 46% and $438,000 or 21% in the third
quarter and first nine months of 2009, respectively. Effective July 1, 2009,
the automobile liability, automobile physical damage and other liability
lines of insurance in the political subdivision program that were previously
written by NAICO are being written by an unaffiliated insurance company
through an arrangement with CIMI. Under this arrangement, CIMI will receive
commission income for the business it produces. 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 the unaffiliated insurance company. NAICO will continue to
write workers compensation coverages for this program and has agreed to
reinsure on a quota share basis 35% of the first $1,000,000 of loss per
occurrence of the other liability business in this program. Because of
these changes, NAICO expects its future premiums earned for this program to
decrease significantly.
NET INVESTMENT INCOME AND NET REALIZED INVESTMENT GAINS
At September 30, 2009, Chandler USA's investment portfolio consisted
primarily of fixed income U.S. Treasury and government agency bonds, high-
quality corporate and tax exempt bonds and certificates of deposit insured by
the FDIC, with approximately 6% invested in cash and money market instruments.
Income generated from this portfolio is largely dependent upon prevailing
levels of interest rates. Chandler USA's portfolio contains no non-investment
grade bonds or real estate investments. Chandler USA also receives interest
income from related parties on intercompany loans.
Net investment income, excluding interest income from related parties
increased $10,000 or 1% and decreased $186,000 or 7% in the third quarter and
first nine months of 2009, respectively. The decrease in the first nine
months of 2009 was due primarily to lower interest rates. Cash and invested
assets were $110.0 million at September 30, 2009 compared to $103.7 million
at December 31, 2008 and $96.7 million at September 30, 2008. Net interest
income from related parties decreased $48,000 or 30% and $179,000 or 35% in
the third quarter and first nine months of 2009, respectively, due to lower
interest rates.
Net realized investment gains were $194,000 and $1.4 million during the
third quarter and first nine months of 2009, respectively. The realized gains
resulted from sales of fixed maturities available for sale in the amount of
$26.0 million. Net realized investment gains were $91,000 and $95,000 during
the third quarter and first nine months of 2008.
OTHER INCOME
Other income was $825,000 and $1.6 million in the third quarter and
first nine months of 2009, respectively, compared to $731,000 and $1.6 million
in the third quarter and first nine months of 2008. The increase in the third
quarter of 2009 was due primarily to an increase in commission income related
to business produced by CIMI for insurance companies other than NAICO.
LOSSES AND LOSS ADJUSTMENT EXPENSES
Chandler USA estimates losses and loss adjustment expenses based on
historical experience and payment and reporting patterns for the type of risk
involved. These estimates are based on data available at the time of the
estimate and are periodically reviewed by independent professional actuaries.
Although such estimates are management's best estimates of the expected values,
the ultimate liability for unpaid claims may vary from these values.
The percentage of losses and loss adjustment expenses to net premiums
earned ("loss ratio") was 60.6% and 60.9% for the third quarter and first nine
months of 2009, compared to 72.3% and 63.3% in the corresponding 2008 periods.
During the third quarter of 2009, NAICO experienced a decrease in losses
incurred related to prior accident years totaling $87,000 which decreased the
loss ratio by 0.7 percentage points. Loss reserve development for the first
nine months of 2009 was redundant by $102,000. In the third quarter of 2008,
losses and loss adjustment expenses incurred related to prior accident years
were $1.7 million and increased the loss ratio by 10.9 percentage points. In
the first nine months of 2008, losses and loss adjustment expenses incurred
related to prior accident years were $1.2 million which increased the loss
ratio by 2.5 percentage points.
PAGE 18
Weather-related losses from wind and hail totaled $13,000 and $92,000 in
the third quarter and first nine months of 2009 and increased the respective
loss ratios by 0.1 and 0.2 percentage points. Weather-related losses totaled
$18,000 and $322,000 in the third quarter and first nine months of 2008, and
increased the respective 2008 loss ratios by 0.1 and 0.7 percentage points.
POLICY ACQUISITION COSTS
Policy acquisition costs consist of costs associated with the acquisition
of new and renewal business and generally include direct costs such as premium
taxes, commissions to agents and ceding companies and premium-related
assessments and indirect costs such as salaries and expenses of personnel who
perform and support underwriting activities. NAICO also receives ceding
commissions from the reinsurers who assume premiums from NAICO under certain
reinsurance contracts and the ceding commissions are accounted for as a
reduction of policy acquisition costs. Direct policy acquisition costs and
ceding commissions are deferred and amortized over the terms of the policies.
When the sum of anticipated losses, loss adjustment expenses and unamortized
policy acquisition costs exceeds the related unearned premiums, including
anticipated investment income, a provision for the indicated deficiency is
recorded.
The following table sets forth Chandler USA's policy acquisition costs
for each of the periods indicated:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
2009 2008 2009 2008
-------- -------- -------- --------
(In thousands)
Commissions expense .......................... $ 3,049 $ 3,306 $ 9,667 $10,584
Other premium related assessments ............ 324 293 863 840
Premium taxes ................................ 394 471 1,328 1,471
Excise taxes ................................. 53 65 174 201
Other expense ................................ 110 111 357 416
-------- -------- -------- --------
Total direct expenses ........................ 3,930 4,246 12,389 13,512
Indirect underwriting expenses ............... 1,491 1,649 4,381 4,832
Commissions received from reinsurers ......... (2,473) (2,855) (8,007) (8,856)
Adjustment for deferred acquisition costs .... (7) 57 (28) (24)
-------- -------- -------- --------
Net policy acquisition costs ................. $ 2,941 $ 3,097 $ 8,735 $ 9,464
======== ======== ======== ========
Total gross direct and indirect expenses as a percentage of direct written
and assumed premiums were 26.6% and 25.3% for the third quarter and first
nine months of 2009, compared to 24.4% and 24.6% in the corresponding year
ago periods. Commissions expense as a percentage of gross written and
assumed premiums was 14.9% and 14.6% in the third quarter and the first nine
months of 2009 compared to 13.7% and 14.2% in the corresponding 2008 periods.
Indirect underwriting expenses decreased $158,000 and $451,000 in the
third quarter and first nine months of 2009, respectively, and were 7.3% and
6.6% of total direct written and assumed premiums in the third quarter and
first nine months of 2009, respectively, compared to 6.8% and 6.5% in the
corresponding 2008 periods. Indirect expenses include general overhead and
administrative costs associated with the acquisition of new and renewal
business, some of which is relatively fixed in nature, thus, the percentage
of such expenses to direct written and assumed premiums will vary depending
on Chandler USA's overall premium volume. Commissions received from
reinsurers as a percent of ceded reinsurance premiums were 31.0% and 31.5%
in the third quarter and first nine months of 2009, respectively, compared
to 31.8% and 32.3% in the corresponding 2008 periods.
PAGE 19
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses decreased $462,000 and $917,000 in
the third quarter and first nine months of 2009, respectively, and were
12.1% and 12.3% of gross premiums earned and other income in the third quarter
and first nine months of 2009, respectively, compared to 12.3% and 12.1% for
the corresponding 2008 periods. General and administrative expenses have
historically not varied in direct proportion to Chandler USA's revenues. A
portion of such expenses is allocated to policy acquisition costs (indirect
underwriting expenses) and loss and loss adjustment expenses based on various
factors including employee counts, salaries, occupancy and specific
identification. Because certain types of expenses are fixed in nature, the
percentage of such expenses to revenues will vary depending on Chandler USA's
overall premium volume.
INTEREST EXPENSE
Interest expense decreased $43,000 and $129,000 in the third quarter and
first nine months of 2009, respectively, compared to the 2008 periods.
Substantially all of Chandler USA's interest expense is related to its
outstanding senior debentures and junior subordinated debentures. The
decrease in the 2009 periods was due to lower interest rates during 2009, as
a portion of Chandler USA's junior subordinated debentures were issued with
a floating interest rate.
LIQUIDITY AND CAPITAL RESOURCES
In the first nine months of 2009, Chandler USA provided $5.5 million in
cash from operations. Unpaid losses and loss adjustment expenses increased
$3.7 million, premiums receivable decreased $4.9 million and policyholder
deposits increased $1.1 million during the first nine months of 2009. These
were partially offset by an increase in reinsurance recoverable on unpaid
losses of $3.8 million and a decrease in unearned premiums of $1.6 million.
In the first nine months of 2008, Chandler USA provided $1.9 million in cash
from operations. Unpaid losses and loss adjustment expenses increased $3.2
million during the first nine months of 2008, but this was partially offset
by an increase in reinsurance recoverable on paid losses of $2.3 million and
a decrease in unearned premiums of $1.9 million.
NAICO is required to deposit cash and securities with regulatory agencies
in which it is licensed as a condition of conducting operations in the state.
In addition, NAICO has deposited cash and securities into a trust account as
collateral for a reinsurance agreement in which NAICO is the assuming
reinsurer. During the third quarter of 2009, NAICO established a letter of
credit in the amount of $500,000 and pledged cash and investments in this
amount. The letter of credit secures reserves assumed under a quota share
reinsurance agreement. At September 30, 2009, the total amount of cash and
securities restricted as a result of these arrangements was $36.1 million
which was an increase of $538,000 from December 31, 2008.
At September 30, 2009, Chandler USA's parent company, Chandler Insurance
Company, Ltd., owed approximately $12.3 million to Chandler USA versus $11.9
million at December 31, 2008 under an Intercompany Credit Agreement (the
"Credit Agreement") covering intercompany loans between the parties. The
Credit Agreement requires interest to be paid at the prime interest rate
published in the Wall Street Journal each month, and balances owed by either
party are payable at any time upon demand.
During March 2001, Chandler USA entered into a $3.8 million sale and
leaseback transaction for certain owned equipment for three years. During
March 2004, the lease was extended for three years and during March 2007,
the lease was extended for an additional three years with monthly rental
installments equal to the sum of (i) $13,834 plus (ii) interest on the unpaid
lease balance at 1% over JP Morgan Chase Bank prime which was 4.25% at
September 30, 2009. Chandler USA has the option to repurchase the equipment
at the end of the lease for approximately $1.9 million (the "Balloon
Payment"), or may elect to have the lessor sell the equipment. If the
election to sell the equipment is made, Chandler USA would retain any proceeds
exceeding the Balloon Payment. If the proceeds were less than the Balloon
Payment, Chandler USA would be required to pay the difference between the
proceeds and the Balloon Payment, not to exceed approximately $1.5 million.
Chandler USA is a holding company receiving cash principally through
borrowings, subsidiary dividends and other payments, subject to various
regulatory restrictions. The capacity of insurance companies to write
insurance is based on maintaining liquidity and capital resources sufficient
to pay claims and expenses as they become due. The primary sources of
liquidity for Chandler USA's subsidiaries are funds generated from insurance
premiums, investment income, capital contributions from Chandler USA and
proceeds from sales and maturities of portfolio investments. The principal
expenditures are payment of losses and loss adjustment expenses, insurance
operating expenses and commissions.
PAGE 20
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 cash shareholder
dividends of $500,000 to Chandler USA in March 2009 and $900,000 in June 2009.
NAICO paid cash shareholder dividends of $1,000,000 to Chandler USA in June
2008 and $1,050,000 in September 2008.
In addition to the statutory limits described above, the amount of
shareholder dividends and other payments to affiliates can be further limited
by contractual or regulatory restrictions or other agreements with regulatory
authorities restricting dividends and other payments, including regulatory
restrictions that are imposed as a matter of administrative policy. If
insurance regulators determine that payment of a shareholder dividend or other
payments to an affiliate (such as payments under a tax sharing agreement,
payments for employee or other services, or payments pursuant to a surplus
note) would be hazardous to such insurance company's policyholders or
creditors, the regulators may block such payments that would otherwise be
permitted without prior approval.
Historically, NAICO has played a significant role in the servicing of
debt and other obligations of Chandler USA through the payment of shareholder
dividends. These obligations include $7.0 million of 8.75% senior debentures
due in 2014, $13.4 million of 9.75% junior subordinated debentures due in
2033, $7.2 million of floating rate junior subordinated debentures due in
2034 and the obligations under the sale and leaseback transaction discussed
previously. To the extent that the restrictions discussed previously limit
NAICO's ability to pay shareholder dividends or other payments to Chandler
USA, Chandler USA's ability to satisfy the debt obligations may also be limited.
LITIGATION
In October 1999, NAICO provided surety bonds for Gulsby Engineering, Inc.
("Gulsby") in connection with contracts between Gulf Liquids New River Project,
LLC ("Gulf Liquids") and Gulsby for the construction of two gas processing
plants in Louisiana. During 2001, Gulsby became unable to pay various vendors
resulting in payments to vendors by NAICO totaling $20,182,499. In August
2001, NAICO filed suit in federal court in Louisiana alleging that Gulf Liquids
had breached its obligations under the bonds by materially altering certain
contracts and that as a result, NAICO was exonerated on the bonds and should
recover the amounts paid to vendors. In the fall of 2001, Gulsby and Bay
Limited, another contractor with whom Gulsby had entered into a joint venture
for the construction of other gas processing plants for Gulf Liquids, filed
lawsuits relating to those plants in Houston, Texas. Gulf Liquids filed
original actions and counterclaims. NAICO intervened in the Texas lawsuits
and, in addition, sued Williams Energy Marketing and Trading (which later
became Williams Power Company, Inc.) ("Williams") alleging fraud, breach of
contract, tortious interference with contractual relations, conspiracy and
alter ego. These claims were asserted against both Gulf Liquids and Williams.
Gulf Liquids asserted counterclaims alleging breach of contract against NAICO
and requesting contractual and statutory damages ranging from $40 million to
$80 million. The cases were consolidated for trial in the 215th Judicial
District Court in Harris County, Texas. On August 1, 2006, the jury trial
concluded in Harris County, Texas, related to the construction of two gas
processing plants in Louisiana. The amounts the jury found owing to NAICO
included approximately $20.2 million in actual damages and $70.0 million in
punitive damages. See Note 4 of Notes to Consolidated Financial Statements
for a discussion of this jury verdict.
PAGE 21
On January 28, 2008, the court entered a final judgment denying Gulf
Liquid's claims against NAICO and Gulsby, denying all of NAICO's claims against
Gulf Liquids and Williams, and entering judgment for Gulsby against Gulf
Liquids for $15,651,927 plus interest at 7.25% compounded annually from
January 28, 2008 until paid. The court also ordered Gulf Liquids to pay
Gulsby's taxable court costs, estimated at $100,000. Gulf Liquids has appealed
the judgment entered in favor of Gulsby and the denial of its claims against
NAICO and Gulsby. NAICO has appealed the trial court's denial of its claims
against Gulf Liquids and Williams and seeks entry of judgment upon the jury
verdicts for the amounts the jury found should be awarded to NAICO. Gulsby has
also appealed the trial court's final judgment, contending that judgment should
be entered in its favor against Gulf Liquids and Williams in accordance with
the jury verdicts. The recoverable amounts deducted from Chandler USA's net
liability for losses and loss adjustment expenses related to this litigation
were approximately $10.1 million at September 30, 2009 and December 31, 2008.
ITEM 4T. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
As of the end of the period covered by this report and pursuant to Rule
13a-15 of the Securities Exchange Act of 1934 (the "Exchange Act"), Chandler
USA's management, including the Chief Executive Officer and Chief Financial
Officer, conducted an evaluation of the effectiveness and design of Chandler
USA's disclosure controls and procedures (as that term is defined in Rules
13a-15(e) and 15d-15(e) of the Exchange Act). Based upon that evaluation,
Chandler USA's Chief Executive Officer and Chief Financial Officer concluded,
as of the end of the period covered by this report, that Chandler USA's
disclosure controls and procedures were effective in recording, processing,
summarizing and reporting information required to be disclosed by Chandler
USA, within the time periods specified in the Securities and Exchange
Commission's rules and forms.
CHANGES IN INTERNAL CONTROLS
In addition and as of the end of the period covered by this report, there
have been no changes in internal control over financial reporting (as defined
in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) during the quarter to
which this report relates that have materially affected or are reasonably
likely to materially affect, the internal control over financial reporting.
PAGE 22
PART II. OTHER INFORMATION
-----------------
Item 1. LEGAL PROCEEDINGS
-----------------
Chandler USA and its subsidiaries are not parties to any material
litigation other than as is routinely encountered in their
respective business activities. While the outcome of these matters
cannot be predicted with certainty, Chandler USA does not expect
these matters to have a material adverse effect on its financial
condition, results of operations or cash flows. See Note 4 of
Notes to Interim Consolidated Financial Statements for a discussion
of a favorable jury verdict in civil litigation regarding certain
surety bond claims.
Item 1A. RISK FACTORS
------------
There have been no material changes from risk factors previously
disclosed in our Annual Report on Form 10-K for the year ended
December 31, 2008.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
-----------------------------------------------------------
None.
Item 3. DEFAULTS UPON SENIOR SECURITIES
-------------------------------
None.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
None.
Item 5. OTHER INFORMATION
-----------------
None.
Item 6. EXHIBITS
--------
31.1 Rule 13a-14(a)/15d-14(a) Certifications.
32.1 Section 1350 Certifications.
PAGE 23
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 9, 2009 CHANDLER (U.S.A.), INC.
By: /s/ W. Brent LaGere
--------------------------------------
W. Brent LaGere
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
By: /s/ Mark C. Hart
--------------------------------------
Mark C. Hart
Senior Vice President - Finance, Chief
Financial Officer and Treasurer
(Principal Accounting Officer