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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2009
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 AMEX 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 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 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, 2009, 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, 2010 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 230 at December 31, 2009, 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, other liability (including general liability, products liability
and umbrella liability) and property and inland marine 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.
Effective January 1, 2007, the property and inland marine lines of
insurance that were previously written by NAICO in the standard lines
program were written by Praetorian Insurance Company ("Praetorian")
through an arrangement between Praetorian and CIMI. Under this
arrangement, CIMI received commission income for the business it
produced for Praetorian. CIMI and Praetorian terminated this
arrangement effective June 29, 2009, and NAICO resumed writing these
lines of insurance in this program.
PAGE 2
POLITICAL SUBDIVISIONS PROGRAM
Under the political subdivisions program, NAICO has written insurance
policies primarily for school districts in Oklahoma. The coverages offered
included 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 were written by Praetorian through an arrangement
between Praetorian and CIMI. CIMI and Praetorian terminated this arrangement
effective June 29, 2009. Effective July 1, 2009, the property, inland
marine, automobile liability, automobile physical damage and other liability
lines of insurance in the political subdivisions program that were previously
written by NAICO are being written by Greenwich Insurance Company
("Greenwich") through an arrangement with CIMI. Under this arrangement, CIMI
receives 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 Greenwich. 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.
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 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 2007, 2008 and 2009. The term "gross
premiums earned" means gross premiums written (before reductions for premiums
ceded to reinsurers) less the increases or plus the decreases in the gross
unearned premium reserve for the unexpired portion of the policy term beyond
the current accounting period. The term "net premiums earned" means gross
premiums earned less reductions for earned premiums ceded to reinsurers.
See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS."
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
-------------------------- --------------------------
INSURANCE PROGRAMS 2007 2008 2009 2007 2008 2009
- ---------------------------------------- -------- -------- -------- -------- -------- --------
(In thousands)
Standard lines ......................... $100,844 $ 96,587 $ 87,100 $ 62,342 $ 61,047 $ 54,129
Political subdivisions ................. 5,084 4,191 2,955 3,436 2,747 1,925
Homeowners ............................. 501 - - 9 - -
Surety bonds ........................... 266 119 101 186 83 70
Other (1) .............................. 214 150 236 212 150 236
-------- -------- -------- -------- -------- --------
TOTAL .................................. $106,909 $101,047 $ 90,392 $ 66,185 $ 64,027 $ 56,360
======== ======== ======== ======== ======== ========
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<FN>
(1) This category is comprised primarily of the run-off of discontinued programs and NAICO's
participation in various mandatory workers compensation pools.
PAGE 3
LINES OF INSURANCE
The lines of insurance written by NAICO through its programs are automobile
liability, other liability (including general liability, products liability
and umbrella liability), workers compensation, automobile physical damage,
property, 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,
--------------------------------------------
2005 2006 2007 2008 2009
-------- -------- -------- -------- --------
Workers compensation ........ 25% 23% 27% 32% 38%
Automobile liability ........ 29% 32% 40% 34% 30%
Other liability ............. 27% 25% 23% 25% 23%
Automobile physical damage .. 9% 8% 9% 9% 9%
Property .................... 8% 11% 1% -% -%
Inland marine ............... 1% 1% -% -% -%
Surety ...................... 1% -% -% -% -%
-------- -------- -------- -------- --------
Total 100% 100% 100% 100% 100%
======== ======== ======== ======== ========
NAICO discontinued its homeowners program during 2006, and also transferred
its property and inland marine business for the standard lines and political
subdivisions programs to Praetorian from January 2007 to the second quarter
of 2009 through an arrangement between Praetorian and CIMI. In July 2009,
Greenwich began writing the property and inland marine business, as well as
certain other lines of insurance, for the political subdivisions program
through an arrangement between Greenwich and CIMI. Because of these
changes, NAICO's net premiums earned for property and inland marine business
in 2007, 2008 and 2009 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.
From January 2007 to the second quarter of 2009, CIMI administered certain
property and inland marine business for Praetorian under a general agency
agreement between the parties. CIMI and Praetorian terminated this
arrangement effective June 29, 2009. Effective July 1, 2009, the property,
inland marine, automobile liability, automobile physical damage and other
liability lines of insurance in NAICO's political subdivisions program are
being written by Greenwich through an arrangement with CIMI. CIMI receives
commission income for its services under the agreement, and is responsible
for the payment of commissions to the producing agents. CIMI is also
responsible for providing underwriting and loss control services for this
business. See "Insurance Programs" for more information.
UNDERWRITING AND CLAIMS
Independent insurance agents submit applications for commercial insurance
policies for prospective customers to NAICO or CIMI. Prospective risks are
reviewed in accordance with specific underwriting guidelines. If the risk
is approved and coverage is accepted by the insured, an insurance policy
is issued.
NAICO's claims department reviews and administers all claims except claims
associated with the homeowners program which were 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. NAICO also handles
claims for the business placed by CIMI with Praetorian and Greenwich under
claims handling agreements with these insurers.
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, 2010.
NAICO has structured separate reinsurance programs for property (including
inland marine), workers compensation, casualty (including automobile
liability, general and products liability, umbrella liability and related
professional liability), automobile physical damage 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.
Effective April 1, 2009, NAICO retains 70% of the first $250,000 of risk for
each loss per risk or per location under its property reinsurance program.
NAICO had previously 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 and property
(including inland marine) coverages to limit its retention for single loss
occurrences involving multiple policies and/or policyholders resulting from
perils such as floods, winds and severe storms. This catastrophe protection
limits NAICO's net retained loss for automobile physical damage to
$1,400,000 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, 2009.
CEDED REINSURANCE
NET PREMIUMS FOR A.M. BEST
REINSURANCE THE YEAR ENDED COMPANY
NAME OF REINSURER RECOVERABLE (1) DECEMBER 31, 2009 RATING
- ---------------------------------------------------------- --------------- ------------------ -----------
(Dollars in thousands)
Chandler Insurance ....................................... $ 33,636 $ 23,994 (2)
Swiss Reinsurance America Corporation (3)................. 16,448 289 A
Westport Insurance Corporation (3)........................ 8,837 - A
Transatlantic Reinsurance Company ........................ 4,395 2,390 A
Markel Insurance Company ................................. 3,875 1,841 A
--------------- ------------------
Top five reinsurers ................................. $ 67,191 $ 28,514
=============== ==================
All reinsurers ...................................... $ 73,964 $ 34,647
=============== ==================
Percentage of total represented by top five reinsurers ... 91% 82%
- -------------------------------------------------------------
<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, 2009.
(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, 2009, Chandler Insurance had cash and investments, including
accrued interest, with a fair value of $33.1 million deposited in a trust account for the benefit
of NAICO, and also had premiums receivable of $522,000 due from 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 $356,000, $166,000 and $180,000 during 2007, 2008 and
2009, 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,
------------------------------------------------
2005 2006 2007 2008 2009
-------- -------- -------- -------- --------
(Dollars in thousands)
Workers compensation:
Net premiums earned ......................... $ 16,475 $ 15,361 $ 17,861 $ 20,681 $ 21,267
Loss ratio .................................. 53% 63% 62% 76% 79%
Automobile liability:
Net premiums earned ......................... $ 19,126 $ 21,122 $ 26,469 $ 21,537 $ 16,816
Loss ratio .................................. 82% 99% 74% 70% 67%
Other liability:
Net premiums earned ......................... $ 18,052 $ 16,628 $ 15,137 $ 16,301 $ 12,826
Loss ratio .................................. 48% 57% 32% 38% 27%
Automobile physical damage:
Net premiums earned ......................... $ 5,807 $ 5,008 $ 6,096 $ 5,492 $ 4,995
Loss ratio .................................. 56% 63% 55% 75% 50%
Inland marine:
Net premiums earned ......................... $ 337 $ 309 $ 157 $ (68) $ 222
Loss ratio .................................. 162% 30% 19% (5)% (28)%
Property:
Net premiums earned ......................... $ 5,594 $ 7,082 $ 279 $ 1 $ 164
Loss ratio .................................. 41% 41% 64% (750)% (17)%
Surety:
Net premiums earned ......................... $ 669 $ 194 $ 186 $ 83 $ 70
Loss ratio .................................. (255)% (459)% 1,119% (52)% 707%
Total:
Net premiums earned ......................... $ 66,060 $ 65,704 $ 66,185 $ 64,027 $ 56,360
Loss ratio .................................. 57% 69% 63% 64% 61%
Underwriting expense ratio (1) .............. 35% 37% 36% 37% 39%
-------- -------- -------- -------- --------
Combined ratio (1) .......................... 92% 106% 99% 101% 100%
======== ======== ======== ======== ========
- -------------------------------------------------
(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 $10.9 million and $10.8 million at December 31, 2008 and
2009. Included in these recoverable amounts were net recoverables of
$10.1 million in 2008 and 2009, 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,
------------------------------------------------------
2005 2006 2007 2008 2009
---------- ---------- ---------- ---------- ----------
(In thousands)
Net balance at beginning of year ................. $ 44,695 $ 40,549 $ 42,081 $ 45,866 $ 49,068
---------- ---------- ---------- ---------- ----------
Net losses and loss adjustment expenses incurred
related to:
Current year ................................. 30,985 41,644 40,194 38,869 33,480
Prior years .................................. 6,339 3,829 1,199 2,071 734
---------- ---------- ---------- ---------- ----------
Total ...................................... 37,324 45,473 41,393 40,940 34,214
---------- ---------- ---------- ---------- ----------
Net paid losses and loss adjustment expenses
related to:
Current year ................................. (11,171) (12,403) (12,494) (11,856) (10,531)
Prior years .................................. (30,299) (31,538) (25,114) (25,882) (23,358)
---------- ---------- ---------- ---------- ----------
Total ...................................... (41,470) (43,941) (37,608) (37,738) (33,889)
---------- ---------- ---------- ---------- ----------
Net balance at end of year ....................... $ 40,549 $ 42,081 $ 45,866 $ 49,068 $ 49,393
========== ========== ========== ========== ==========
NAICO has experienced incurred losses related to prior accident years
during each of the calendar years in the table above. 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 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.
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 9
During 2009, NAICO experienced adverse loss development totaling
approximately $734,000 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 and other liability lines of business in this program. The
adverse loss development included approximately $180,000 for provisions
for potentially uncollectible reinsurance.
The following table represents the development of net balance sheet reserves
for 2000 through 2009. 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 2003 for
claims that occurred in 2000 will be included in the cumulative deficiency
amount for years 2000, 2001, 2002 and 2003. This table does not present
accident or policy year development data. Conditions and trends that have
affected development of the liability in the past may not necessarily
occur in the future. Accordingly, it may not be appropriate to
extrapolate future deficiencies or redundancies based on this table.
PAGE 10
DEVELOPMENT OF RESERVES
AS OF DECEMBER 31,
-------------------------------------------------------------------------------------------------------
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
---------- ---------- ---------- ---------- --------- --------- --------- --------- --------- ---------
(In thousands)
Net reserve for unpaid losses and
loss adjustment expenses .. $ 46,707 $ 32,812 $ 33,191 $ 29,343 $ 44,695 $ 40,549 $ 42,081 $ 45,866 $ 49,068 $ 49,393
Net paid (cumulative) as of
One year later ........... 43,799 37,050 30,422 28,207 30,299 31,537 25,111 25,882 23,359
Two years later .......... 66,141 60,560 51,375 50,158 50,183 46,348 39,931 40,569
Three years later ........ 81,635 77,413 68,643 63,900 58,263 54,405 45,919
Four years later ......... 91,403 89,349 79,591 69,099 63,164 57,341
Five years later ......... 97,700 98,060 83,845 72,937 64,596
Six years later .......... 99,506 101,213 86,328 73,741
Seven years later ........ 101,257 103,109 87,005
Eight years later ........ 102,461 103,672
Nine years later ......... 102,355
Net liability re-estimated as of
One year later ............ 59,376 48,596 44,283 55,688 51,034 44,378 43,280 47,937 49,802
Two years later ........... 74,325 67,903 70,058 61,369 50,989 50,909 45,071 51,047
Three years later ......... 86,377 89,608 73,962 61,216 57,175 53,585 49,338
Four years later .......... 100,408 91,520 74,805 66,153 59,725 57,108
Five years later .......... 102,370 91,700 79,781 68,663 62,907
Six years later ........... 104,227 96,161 81,643 71,293
Seven years later ......... 106,396 98,123 84,232
Eight years later ......... 107,610 100,672
Nine years later .......... 109,477
Net cumulative (deficiency)
redundancy ................ $ (62,770) $ (67,860) $ (51,041) $ (41,950) $(18,212) $(16,559) $ (7,257) $ (5,181) $ (734) $ -
Supplemental gross data:
Gross liability ........... $ 100,173 $ 84,756 $ 92,606 $ 87,768 $108,233 $109,541 $ 83,253 $100,590 $101,459 $107,341
Reinsurance recoverable ... 53,466 51,944 59,415 58,425 63,538 68,992 41,172 54,724 52,391 57,948
---------- ---------- ---------- ---------- --------- --------- --------- --------- --------- ---------
Net liability-end of year.. $ 46,707 $ 32,812 $ 33,191 $ 29,343 $ 44,695 $ 40,549 $ 42,081 $ 45,866 $ 49,068 $ 49,393
========== ========== ========== ========== ========= ========= ========= ========= ========= =========
Gross re-estimated
liability - latest ....... $ 276,455 $ 304,793 $ 253,927 $ 188,155 $160,708 $139,781 $120,465 $117,954 $105,745
Re-estimated recoverable -
latest ................... 166,978 204,121 169,695 116,862 97,801 82,673 71,127 66,907 55,943
---------- ---------- ---------- ---------- --------- --------- --------- --------- ---------
Net re-estimated
liability - latest ....... $ 109,477 $ 100,672 $ 84,232 $ 71,293 $ 62,907 $ 57,108 $ 49,338 $ 51,047 $ 49,802
========== ========== ========== ========== ========= ========= ========= ========= =========
Gross cumulative (deficiency)
redundancy ................ $(176,282) $(220,037) $(161,321) $(100,387) $(52,475) $(30,240) $(37,212) $(17,364) $ (4,286)
========== ========== ========== ========== ========= ========= ========= ========= =========
PAGE 11
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.
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, 2009, 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, 2009, approximately 96% of total fixed maturity investments
were rated AA or better by Moody's Investor Service, Inc. or Standard &
Poor's. Approximately 3% of total fixed maturities were rated A by Moody's
Investor Service, Inc. or Standard & Poor's, and approximately 1% was rated
BAA by Moody's Investor Service, Inc. and BBB 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, 2009, 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.
PAGE 12
The Junior Debentures I are the sole assets of Trust I and Trust I will
distribute any cash payments it receives thereon to the holders of its
preferred and common securities. Distributions on the Trust I Preferred
Securities are payable quarterly at a fixed annual rate of 9.75%. Trust I
may defer these payments for up to 20 consecutive quarters, but not beyond
the maturity of the Trust I Preferred Securities, with such deferred
payments accruing interest compounded quarterly. The Trust I Preferred
Securities are subject to a mandatory redemption on May 23, 2033, but they
may be redeemed after five years at a premium of half the fixed rate
coupon declining ratably to par in the 10th year. All payments by Trust
I regarding the Trust I Preferred Securities are guaranteed by Chandler USA.
In December 2003, Chandler USA established Chandler Capital Trust II
("Trust II") by purchasing all of its common securities for $217,000.
Trust II is a Delaware statutory business trust and is a wholly owned non-
consolidated subsidiary of Chandler USA. On December 16, 2003, Trust II
issued $7.0 million of capital securities (the "Trust II Preferred
Securities") to InCapS Funding II, Ltd., an unaffiliated company established
under the laws of the Cayman Islands, in a private transaction. Trust II
used the proceeds from the issuance to purchase $7,217,000 of floating rate
junior subordinated debentures (the "Junior Debentures II") of Chandler USA.
Distributions on the Junior Debentures II are payable quarterly at a
floating rate of 4.10% over LIBOR (LIBOR is recalculated quarterly). The
interest rate was 4.38% at December 31, 2009. 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 4.38% at December
31, 2009. 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.
Trust I and Trust II are variable interest entities in which Chandler USA
is not the primary beneficiary under GAAP because its interest is not
variable. Therefore, Chandler USA is prohibited from consolidating these
trusts even though it has 100% ownership, complete voting control and has
guaranteed the performance of the trusts. Accordingly, Chandler USA
carries the Junior Debentures I and Junior Debentures II as a liability on
its consolidated balance sheets.
EMPLOYEES AND ADMINISTRATION
At December 31, 2009, Chandler USA and its subsidiaries had 187 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 2009 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
from 2006 through 2009. 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, 2009, NAICO had statutory earned surplus of $15.5
million. Applying the Oklahoma statutory limits described above, the
maximum shareholder dividend NAICO may pay in 2010 without the approval
of the Oklahoma Department of Insurance is $5.4 million. NAICO paid
shareholder dividends to Chandler USA totaling $2.1 million and $1.4
million in 2008 and 2009, 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 6.5:1 and 7.3:1 at December 31, 2008 and 2009, respectively.
Therefore, NAICO's total adjusted capital exceeds the level that would
trigger regulatory attention pursuant to the risk-based capital requirement.
NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS-IRIS RATIOS
The National Association of Insurance Commissioners Insurance Regulatory
Information System ("IRIS") was developed by a committee of state insurance
regulators and is primarily intended to assist state insurance departments
in executing their statutory mandates to oversee the financial condition of
insurance companies operating in their respective states. IRIS identifies
13 industry ratios and specifies "usual values" for each ratio. Departure
from the "usual values," which fluctuate annually, on four or more ratios
generally leads to inquiries from individual state insurance commissioners.
NAICO had one 2009 ratio that was outside of the "usual values".
NAICO's "investment yield" as calculated using the IRIS formula was 2.9%
during 2009 compared to a usual value of greater than 3.0% and less than
6.5%. NAICO maintains a high-quality investment portfolio, with no non-
investment grade bonds, derivative instruments or real estate investments
(other than real estate occupied by the company). NAICO's investment
yield is largely dependent upon prevailing levels of interest rates. The
significant decline in interest rates in recent years had a significant
impact on NAICO's investment yield. NAICO has also increased its holdings
of tax-exempt bonds, which generally have lower yields due to their tax
advantaged status.
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 2009 Annual Report on Form 10-K, should be considered carefully.
IF OUR ACTUAL LOSSES EXCEED OUR LOSS RESERVES, OUR FINANCIAL RESULTS WOULD
BE ADVERSELY AFFECTED.
We maintain reserves for unpaid losses and loss adjustment expenses which
are estimates of the expense of investigation and settlement of all reported
and incurred but not reported losses under our previously issued insurance
policies and/or reinsurance contracts. These reserves do not represent an
exact measurement of liability, but are estimates based upon historical
data and anticipated future events. The process of estimating loss reserves
is complex and imprecise. We periodically review the reserve estimates and
the methods used to arrive at such reserve estimates, and we also retain
independent professional actuaries who review such reserve estimates and
methods. Any changes that result from these reviews are reflected in
current operating results.
If our estimates are incorrect and our reserves are inadequate, we are
required to increase our reserves. An increase in reserves results in an
increase in losses and a reduction in our net income for the period in
which the deficiency is identified. Accordingly, an increase in reserves
could have a material adverse effect on our results of operations,
liquidity and financial condition.
CATASTROPHIC EVENTS AND ACTS OF TERRORISM CAN HAVE A SIGNIFICANT IMPACT ON
OUR RESULTS OF OPERATIONS, LIQUIDITY AND FINANCIAL CONDITION.
We are subject to claims arising out of catastrophes that may have a
significant effect on our results of operations, liquidity and financial
condition. Catastrophes can be caused by various events, including
tornadoes, windstorms, hail, fires, severe winter weather, earthquakes,
power outages and explosions, and may include man-made events such as
terrorist attacks. The frequency and severity of these catastrophes are
inherently unpredictable. The extent of losses from a catastrophe is a
function of both the total amount of insured exposure in the area affected
by the event and the severity of the event.
PAGE 16
We seek to reduce the impact of a catastrophe on our business through the
purchase of catastrophe and terrorism reinsurance. Reinsurance does not
relieve us of our direct liability to our policyholders. As long as the
reinsurers meet their obligations, our net liability is limited to the
amount of risk that we retain. Reinsurance, however, may prove inadequate
if a major catastrophic loss exceeds the reinsurance limit or the
reinsurers' financial capacity.
OUR RESULTS MAY FLUCTUATE BASED ON MANY FACTORS, INCLUDING CYCLICAL CHANGES
IN THE INSURANCE INDUSTRY.
The results of companies in the property and casualty insurance industry
historically have been subject to significant fluctuations and uncertainties.
The industry's profitability can be affected significantly by rising levels
of claim costs that are not known by companies at the time they price their
products. The property and casualty insurance industry historically is
cyclical. The demand for property and casualty insurance can vary
significantly, generally rising as the overall level of economic activity
increases and falling as such activity decreases. The property and casualty
insurance industry also has been very competitive. During the late 1990's
and into 2000, property and casualty insurance companies generally under
priced their products, which resulted in poor underwriting results that
were partially offset by investment returns. Interest rates decreased in
2000 and underwriting results continued to deteriorate for business written
in the late 1990's and into 2000. These factors coupled with additional
potential losses due to terrorism and lower investment returns caused the
industry to increase pricing beginning in the latter half of 2001. Rate
increases continued through 2003 and to a lesser extent in 2004, and the
industry's underwriting results improved. The pricing environment during
2005 through 2009 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 from 2006 through 2009. 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, 2009, approximately 96% of our fixed
maturity investments were rated AA or better by Moody's Investor Service,
Inc. or Standard & Poor's. Approximately 3% of total fixed maturities were
rated A by Moody's Investor Service, Inc. or Standard & Poor's, and
approximately 1% was rated BAA by Moody's Investor Service, Inc. and BBB 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 through 2009, 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 2009, approximately 78% 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. RESERVED.
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, 2009 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,
-------------------------------------------------
2005 2006 2007 2008 2009
--------- --------- --------- --------- ---------
(Dollars in thousands)
OPERATING DATA
Revenues
Direct premiums written and assumed .................... $120,344 $113,043 $100,081 $ 98,384 $ 91,185
========= ========= ========= ========= =========
Net premiums earned .................................... $ 66,060 $ 65,704 $ 66,185 $ 64,027 $ 56,360
Investment income, net (1) ............................. 2,798 9,801 (572) 3,347 3,168
Interest income, net from related parties .............. 670 792 941 647 438
Realized investment gains, net ......................... 383 745 214 95 1,527
Other income ........................................... 251 317 1,916 2,069 2,037
--------- --------- --------- --------- ---------
Total revenues ........................................... 70,162 77,359 68,684 70,185 63,530
--------- --------- --------- --------- ---------
Operating expenses
Losses and loss adjustment expenses .................... 37,324 45,473 41,393 40,940 34,214
Policy acquisition costs ............................... 10,671 11,666 12,547 12,348 12,044
General and administrative expenses .................... 12,749 12,469 12,790 13,124 11,437
Interest expense ....................................... 2,535 2,690 2,703 2,569 2,357
--------- --------- --------- --------- ---------
Total operating expenses ................................. 63,279 72,298 69,433 68,981 60,052
--------- --------- --------- --------- ---------
Income (loss) before income taxes ........................ 6,883 5,061 (749) 1,204 3,478
Federal income tax benefit (provision) ................... (2,450) (1,665) 87 (679) (1,296)
--------- --------- --------- --------- ---------
Net income (loss) ........................................ $ 4,433 $ 3,396 $ (662) $ 525 $ 2,182
========= ========= ========= ========= =========
Combined loss and underwriting expense ratio (2) ......... 92% 106% 99% 101% 100%
BALANCE SHEET DATA
Cash and investments ..................................... $ 86,316 $ 89,703 $ 97,199 $103,673 $111,073
Amounts due from related parties ......................... 9,360 9,584 11,506 11,869 12,697
Total assets ............................................. 245,059 222,772 234,367 234,647 247,345
Unpaid losses and loss adjustment expenses ............... 109,541 83,253 100,590 101,459 107,341
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 ........................................ 205,373 179,808 190,763 189,282 200,172
Shareholder's equity ..................................... 39,686 42,964 43,604 45,365 47,173
- ------------------------------------------------------------
<FN>
(1) Net investment income included $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. NAICO 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 terminated this arrangement effective June 29, 2009.
Effective July 1, 2009, the property, inland marine, automobile liability,
automobile physical damage and other liability lines of insurance in NAICO's
political subdivisions program are being written by Greenwich through an
arrangement with CIMI. See "Insurance Programs" for more information. NAICO
markets these products through a network of independent insurance agents. A
portion of the insurance written by NAICO is reinsured by Chandler USA's
parent Chandler Insurance. CIMI is an underwriting manager and wholesaler
that offers multiple insurance products for businesses in various industries
and political subdivisions.
SUMMARY OF RESULTS
For the year ended December 31, 2009, Chandler USA had net income of $2.2
million compared to $525,000 for 2008 and a net loss of $662,000 for 2007.
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, 2009, NAICO's case
reserves and IBNR for each line of business are shown in the following table.
Gross reserves at December 31, 2009 Net reserves at December 31, 2009
----------------------------------- ---------------------------------
Case Total Case Total
reserves IBNR reserves reserves IBNR reserves
----------- ----------- ----------- ---------- ---------- -----------
(In thousands) (In thousands)
Workers compensation ......... $ 35,033 $ 26,738 $ 61,771 $ 14,915 $ 12,118 $ 27,033
Automobile liability ......... 22,363 12,503 34,866 15,902 7,211 23,113
Other liability .............. 4,424 26,683 31,107 2,621 7,706 10,327
Automobile physical damage ... 226 - 226 159 - 159
Property ..................... 7 - 7 - - -
Surety ....................... (20,922) 285 (20,637) (11,239) - (11,239)
Accident and health .......... 1 - 1 - - -
Inland marine ................ - - - - - -
----------- ----------- ----------- ---------- ---------- -----------
Total reserves .............. $ 41,132 $ 66,209 $ 107,341 $ 22,358 $ 27,035 $ 49,393
=========== =========== =========== ========== ========== ===========
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, 2009.
Lines of Insurance Low High Recorded
------------------------------------------- --------- ---------- ----------
(In thousands)
Gross Reserves
--------------
Workers compensation .................... $ 41,540 $ 63,574 $ 55,424
Automobile liability .................... 25,510 36,776 34,066
Other liability ......................... 17,747 68,529 30,267
Automobile physical damage .............. 223 956 223
Surety bonds ............................ (20,643) (20,643) (20,643)
Involuntary workers compensation pools .. 5,085 5,085 5,085
Other ................................... 2,919 2,919 2,919
--------- ---------- ----------
Total ................................. $ 72,381 $ 157,196 $ 107,341
========= ========== ==========
Net Reserves
--------------
Workers compensation .................... $ 13,016 $ 21,907 $ 20,388
Automobile liability .................... 18,214 26,138 22,314
Other liability ......................... 6,339 15,403 9,487
Automobile physical damage .............. 156 658 156
Surety bonds ............................ (11,245) (11,245) (11,245)
Involuntary workers compensation pools .. 5,085 5,085 5,085
Other ................................... 3,208 3,208 3,208
--------- ---------- ----------
Total ................................. $ 34,773 $ 61,154 $ 49,393
========= ========== ==========
For the workers compensation gross and net reserves, NAICO's actuaries
selected an average of the results of all methods examined for accident years
2000 through 2008. For the 2009 accident year, the actuaries selected the
case incurred projection for both gross and net reserves. For the automobile
liability gross and net reserves, the actuaries relied on the average of the
results of all methods examined for accident years prior to 2009. The 2009
accident year selection was based on a judgmentally selected loss ratio.
General liability gross and net reserves were based on the average of all
methods examined for all accident years except 2008. The case incurred
Bornhuetter-Ferguson projection was selected for the 2008 accident year for
both gross and net reserves. 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 2009 loss reserve
analysis were similar to those used in the 2008 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, 2009. However,
estimating the ultimate claims liability is necessarily a complex and
judgmental process inasmuch as the amounts are based on management's
informed estimates, assumptions and judgments using data currently available.
REINSURANCE RECOVERABLES
Reinsurance recoverables on unpaid losses and loss adjustment expenses
are similarly subject to changes in estimates and assumptions. Amounts
recoverable from reinsurers are estimated in a manner consistent with the
claim liability associated with the reinsured policies. In addition to
factors noted above, estimates of reinsurance recoverables may prove
uncollectible if the reinsurer is unable or unwilling to meet its
responsibilities under the reinsurance contracts. Reinsurance contracts
do not relieve an insurer from its obligation to policyholders.
DEFERRED INCOME TAXES
Chandler USA uses an asset and liability approach for accounting for income
taxes. Deferred income taxes are recognized for the tax consequences of
temporary differences and carryforwards by applying enacted tax rates
applicable to future years to differences between the financial statement
amounts and the tax bases of existing assets and liabilities. A valuation
allowance is established if it is more likely than not that some portion of
the deferred tax asset will not be realized. The determination of whether
a valuation allowance is appropriate requires the exercise of management
judgment.
At December 31, 2007, Chandler USA had a net operating loss carryforward
available for U.S. Federal income taxes of $1.3 million, which was fully
utilized during 2008.
In addition, at December 31, 2009, Chandler USA had net operating loss
carryforwards available for Oklahoma state income taxes totaling
approximately $33.9 million which expire in the years 2010 through 2029.
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 $71.1 million, or 78%, of NAICO's direct written and
assumed premiums in 2009 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 2009 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
from 2006 through 2009. 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,
--------------------------------
2007 2008 2009
---------- ---------- ----------
(Dollars in thousands)
INSURANCE PROGRAMS
- ----------------------------------------
STANDARD LINES
Net premiums earned .................. $ 62,342 $ 61,047 $ 54,129
Loss ratio ........................... 59.5% 63.7% 58.4%
POLITICAL SUBDIVISIONS
Net premiums earned .................. $ 3,436 $ 2,747 $ 1,925
Loss ratio ........................... 46.1% 67.7% 81.2%
HOMEOWNERS
Net premiums earned .................. $ 9 $ - $ -
Loss ratio ........................... (560.0)% -% -%
SURETY BONDS
Net premiums earned .................. $ 186 $ 83 $ 70
Loss ratio ........................... 1,119.1% (51.9)% 704.3%
OTHER (1)
Net premiums earned .................. $ 212 $ 150 $ 236
Loss ratio ........................... 307.2% 127.8% 222.9%
TOTAL
Net premiums earned .................. $ 66,185 $ 64,027 $ 56,360
Loss ratio ........................... 62.5% 63.9% 60.7%
- -------------------------
<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,
--------------------------------
2007 2008 2009
---------- ---------- ----------
(Dollars in thousands)
LINE OF INSURANCE
- ----------------------------------------
WORKERS COMPENSATION
Net premiums earned .................. $ 17,861 $ 20,681 $ 21,267
Loss ratio ........................... 62.2% 75.8% 78.5%
AUTOMOBILE LIABILITY
Net premiums earned .................. $ 26,469 $ 21,537 $ 16,816
Loss ratio ........................... 73.7% 69.6% 67.5%
OTHER LIABILITY
Net premiums earned .................. $ 15,137 $ 16,301 $ 12,826
Loss ratio ........................... 32.4% 37.7% 27.0%
AUTOMOBILE PHYSICAL DAMAGE
Net premiums earned .................. $ 6,096 $ 5,492 $ 4,995
Loss ratio ........................... 55.0% 75.4% 50.4%
INLAND MARINE
Net premiums earned .................. $ 157 $ (68) $ 222
Loss ratio ........................... 18.9% (5.2)% (28.4)%
PROPERTY
Net premiums earned .................. $ 279 $ 1 $ 164
Loss ratio ........................... 63.9% (750.4)% (17.1)%
SURETY
Net premiums earned .................. $ 186 $ 83 $ 70
Loss ratio ........................... 1,119.1% (51.9)% 707.1%
TOTAL
Net premiums earned .................. $ 66,185 $ 64,027 $ 56,360
Loss ratio ........................... 62.5% 63.9% 60.7%
PAGE>
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 2007 2008 2009 2007 2008 2009
- -------------------------------- --------- --------- --------- --------- --------- ---------
(In thousands)
Standard lines ................. $100,844 $ 96,587 $ 87,100 $ 62,342 $ 61,047 $ 54,129
Political subdivisions ......... 5,084 4,191 2,955 3,436 2,747 1,925
Homeowners ..................... 501 - - 9 - -
Surety bonds ................... 266 119 101 186 83 70
Other .......................... 214 150 236 212 150 236
--------- --------- --------- --------- --------- ---------
TOTAL .......................... $106,909 $101,047 $ 90,392 $ 66,185 $ 64,027 $ 56,360
========= ========= ========= ========= ========= =========
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
------------------------------- -------------------------------
LINES OF INSURANCE 2007 2008 2009 2007 2008 2009
- -------------------------------- --------- --------- --------- --------- --------- ---------
(In thousands)
Workers compensation ........... $ 28,337 $ 31,967 $ 32,687 $ 17,861 $ 20,681 $ 21,267
Automobile liability ........... 39,298 31,261 24,441 26,469 21,537 16,816
Other liability ................ 28,995 29,732 25,070 15,137 16,301 12,826
Automobile physical damage ..... 9,021 8,065 7,424 6,096 5,492 4,995
Inland marine .................. 247 (99) 337 157 (68) 222
Property ....................... 745 2 333 279 1 164
Surety ......................... 266 119 100 186 83 70
--------- --------- --------- --------- --------- ---------
TOTAL .......................... $106,909 $101,047 $ 90,392 $ 66,185 $ 64,027 $ 56,360
========= ========= ========= ========= ========= =========
Gross premiums earned decreased 5% and 11% in 2008 and 2009, respectively.
The decrease in 2008 gross premiums earned was due primarily to a decrease
in automobile liability premiums in the standard lines program. During 2009,
the standard lines and political subdivisions programs experienced
significant decreases in gross premiums earned, primarily in the automobile
liability and other liability lines of business. Gross premiums earned in
the workers compensation line of business increased slightly during 2009.
Gross premiums earned in Texas decreased 21% and 14% in 2008 and 2009,
respectively, and gross premiums earned in Oklahoma increased 6% in 2008 and
decreased 2% in 2009.
Net premiums earned decreased 3% in 2008 and 12% in 2009. 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. During 2009, net premiums earned
increased slightly in the workers compensation line of business, but
decreased in the automobile liability and other liability lines of business
due to the decrease in gross premiums earned.
PAGE 29
Gross premiums earned in the standard lines program decreased 4% in 2008
and 10% in 2009. Gross premiums earned for workers compensation business in
this program increased $3.7 million or 13% in 2008, and $651,000 or 2% in
2009. Gross premiums earned from trucking accounts decreased $8.2 million in
2008 and $6.2 million in 2009. Net premiums earned in the standard lines
program decreased 2% in 2008 and 11% in 2009. Net premiums earned from
trucking accounts decreased $4.6 million in 2008 and $4.2 million in 2009.
From January 2007 to the second quarter of 2009, the property and inland
marine lines of insurance that were previously written by NAICO in the
standard lines program were written by Praetorian Insurance Company
("Praetorian") through an arrangement between Praetorian and CIMI. Under
this arrangement, CIMI received commission income for the business it
produced for Praetorian. NAICO handles all claims for this business under
a separate claims handling agreement with Praetorian. CIMI and Praetorian
terminated this arrangement effective June 29, 2009, and NAICO resumed
writing these lines of insurance in this program.
Gross premiums earned in the political subdivisions program decreased 18%
and 29% in 2008 and 2009, respectively. Net premiums earned decreased 20%
and 30% in 2008 and 2009, respectively. From January 2007 to the second
quarter of 2009, the property and inland marine lines of insurance in the
political subdivisions program that were previously written by NAICO were
written by Praetorian through an arrangement between Praetorian and CIMI.
CIMI and Praetorian terminated this arrangement effective June 29, 2009.
Effective July 1, 2009, the property, inland marine, automobile liability,
automobile physical damage and other liability lines of insurance in the
political subdivisions program that were previously written by NAICO are
being written by Greenwich Insurance Company ("Greenwich") 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
Greenwich. NAICO will continue to write workers compensation coverages for
the political subdivisions 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 the political subdivisions program to decrease
significantly.
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 55% and 15% in
2008 and 2009, respectively. Net premiums earned decreased 55% and 16% in
2008 and 2009, 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, 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 7% 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. During 2007, NAICO reversed $4.1 million of
prejudgment interest income based on a final judgment entered by the
court. The prejudgment interest income had been accrued during 2006 on a
favorable jury verdict in civil litigation regarding certain surety bond
claims in 2006. See Litigation and Note 11 of Notes to Consolidated
Financial Statements.
Net investment income, excluding interest income from related parties
and the prejudgment interest, decreased 6% in 2008 and 5% in 2009.
Interest income from related parties was $941,000, $647,000 and $438,000
during 2007, 2008 and 2009, respectively. The decreases in 2008 and 2009
were due to lower interest rates. See Liquidity and Capital Resources.
Net realized investment gains were $214,000, $95,000 and $1,527,000 in
2007, 2008 and 2009, respectively.
PAGE 30
The average net yield on the fixed maturity portfolio, including net
realized investment gains, was 4.0%, 3.4% and 4.3% in 2007, 2008 and 2009,
respectively. The average net yield on the fixed maturity portfolio,
excluding net realized investment gains, was 3.8% for 2007, 3.3% for 2008
and 2.9% for 2009. 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, 2009 was approximately $12.1 million. The average yield on the
fixed maturity portfolio before deducting investment expenses was 4.2% in
2007, 3.6% in 2008 and 3.1% in 2009, excluding net realized capital gains.
OTHER INCOME
Other income was $1.9 million, $2.1 million and $2.0 million during 2007,
2008 and 2009, respectively. Other income included net commission income
related to business produced by CIMI for insurance companies other than
NAICO totaling $1.3 million in 2007, and $1.6 million in 2008 and 2009,
respectively.
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 62.5%, 63.9% and 60.7% in 2007, 2008 and 2009,
respectively. Weather-related losses (net of applicable reinsurance) from
wind and hail were $109,000, $344,000 and $92,000 in 2007, 2008 and 2009,
respectively, and increased the respective loss ratios by 0.2, 0.5 and 0.2
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 from
January 2007 through June 2009. Effective July 1, 2009, the property and
inland marine lines of business in the political subdivisions program are
being written by Greenwich.
NAICO experienced $1.2 million, $2.1 million and $734,000 of incurred
losses related to prior accident years during 2007, 2008 and 2009,
respectively. 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
--------------------------------
2007 2008 2009
---------- ---------- ----------
(In thousands)
Workers compensation ..................... $ 1,314 $ 3,536 $ 3,958
Automobile liability .................... (691) (1,660) (1,966)
Other liability .......................... (1,796) 216 (1,572)
Automobile physical damage ............... 65 1 120
Property ................................. (173) 23 (14)
Surety ................................... 2,074 (49) 489
Accident and health ...................... 394 - (218)
Inland marine ............................ 12 4 (63)
---------- ---------- ----------
$ 1,199 $ 2,071 $ 734
========== ========== ==========
PAGE 31
During 2007, certain surety bond 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. During
2009, workers compensation losses developed adversely by $4.0 million, but
the automobile liability line of business offset approximately $2.0 million
of this, and the other liability line offset approximately $1.6 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.
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
2001 2001 2002 2003 2004 2005 2006 2007 2008 Total
-------- ---------- -------- --------- -------- -------- -------- -------- -------- ---------
(In thousands)
Reserves at beginning of 2007 .. $ 4,596 $ (11,030) $ 1,610 $ 2,132 $ 3,492 $12,051 $29,230 $ - $ - $ 42,081
Development during 2007 ........ 2,169 2,292 515 (39) 1,249 345 (5,332) - - 1,199
-------- ---------- -------- --------- -------- -------- -------- -------- -------- ---------
Re-estimated reserves at
beginning of 2007 ............. $ 6,765 $ (8,738) $ 2,125 $ 2,093 $ 4,741 $12,396 $23,898 $ - $ - $ 43,280
======== ========== ======== ========= ======== ======== ======== ======== ======== =========
Reserves at beginning of 2008 .. $ 5,013 $ (10,139) $ 1,028 $ 1,154 $ 1,855 $ 5,660 $13,618 $27,677 $ - $ 45,866
Development during 2008 ........ 1,214 749 (100) 647 40 125 (884) 280 - 2,071
-------- ---------- -------- --------- -------- -------- -------- -------- -------- ---------
Re-estimated reserves at
beginning of 2008 ............. $ 6,227 $ (9,390) $ 928 $ 1,801 $ 1,895 $ 5,785 $12,734 $27,957 $ - $ 47,937
======== ========== ======== ========= ======== ======== ======== ======== ======== =========
Reserves at beginning of 2009 .. $ 5,024 $ (10,084) $ 339 $ 443 $ 836 $ 2,629 $ 5,980 $16,932 $26,969 $ 49,068
Development during 2009 ........ 1,865 683 40 41 552 341 744 (1,156) (2,376) 734
-------- ---------- -------- --------- -------- -------- -------- -------- -------- ---------
Re-estimated reserves at
beginning of 2009 ............. $ 6,889 $ (9,401) $ 379 $ 484 $ 1,388 $ 2,970 $ 6,724 $15,776 $24,593 $ 49,802
======== ========== ======== ========= ======== ======== ======== ======== ======== =========
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.
During 2009, NAICO experienced adverse loss development totaling
$734,000 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 and other
liability lines of business in this program. The adverse loss development
included approximately $180,000 for provisions for potentially uncollectible
reinsurance.
PAGE 32
Since 2001, 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 2007,
2008 and 2009, NAICO incurred charges of $356,000, $166,000 and $180,000,
respectively, in adjustments to ceded losses and loss adjustment expenses for
amounts deemed uncollectible.
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, 2007, 2008 and 2009:
YEAR ENDED DECEMBER 31,
--------------------------------
2007 2008 2009
---------- ---------- ----------
(In thousands)
Commissions expense .............................. $ 13,987 $ 14,029 $ 13,514
Other premium related assessments ................ 1,020 1,098 1,227
Premium taxes .................................... 2,014 1,965 1,781
Excise taxes ..................................... 280 266 240
Other expense .................................... 789 540 684
---------- ---------- ----------
Total direct expenses ............................ 18,090 17,898 17,446
Indirect underwriting expenses ................... 5,906 6,322 5,815
Commissions received from reinsurers ............. (11,176) (11,686) (10,975)
Adjustment for deferred acquisition costs ........ (273) (186) (242)
---------- ---------- ----------
Net policy acquisition costs ..................... $ 12,547 $ 12,348 $ 12,044
========== ========== ==========
Total gross direct and indirect expenses as a percentage of direct written
and assumed premiums were 24.0% in 2007, 24.6% in 2008 and 25.5% in 2009.
For these periods, commissions expense as a percentage of gross written and
assumed premiums was 14.0%, 14.3% and 14.8%.
Indirect underwriting expenses as a percentage of direct written and
assumed premiums were 5.9% in 2007 and 6.4% in 2008 and 2009, respectively.
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
31.4%, 32.4% and 31.7% in 2007, 2008 and 2009, respectively.
PAGE 33
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were 11.8%, 12.7% and 12.4% of gross
premiums earned and other income in 2007, 2008 and 2009, respectively. 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. During 2009, general and administrative expenses
decreased 12.9%. 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 decreased 5.0% in 2008 and 8.3% in 2009. Substantially
all of Chandler USA's interest expense is related to its outstanding senior
debentures and junior subordinated debentures. The decreases in 2008 and
2009 were due primarily to the decrease in interest rates during these
periods, as a portion of Chandler USA's junior subordinated debentures
were issued with a floating interest rate.
FEDERAL INCOME TAXES
Chandler USA's federal income tax benefit (provision) as a percentage of
income (loss) before income taxes was 11.6%, 56.4% and 37.3% for 2007,
2008 and 2009, respectively. The 2007 percentage was lower than the
percentage expected using U.S. Federal enacted income tax rates due primarily
to the impact of nondeductible expenses on the net loss before income taxes.
The 2008 and 2009 percentages were higher than the percentage expected due
primarily to the impact of nondeductible expenses on net income before
income taxes.
At December 31, 2009, Chandler USA had a net deferred tax asset of $3.1
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.
PAGE 34
As of December 31, 2009, NAICO had statutory earned surplus of $15.5
million. Applying the Oklahoma statutory limits described above, the
maximum shareholder dividend NAICO may pay in 2010 without the approval of
the Oklahoma Department of Insurance is $5.4 million. NAICO paid shareholder
dividends to Chandler USA totaling $2.1 million and $1.4 million during 2008
and 2009, 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.
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, 2009,
approximately 96% of total fixed maturity investments were rated AA or better
by Moody's Investor Service, Inc. or Standard & Poor's. Approximately 3% of
total fixed maturities were rated A by Moody's Investor Service, Inc. or
Standard & Poor's, and approximately 1% was rated BAA by Moody's Investor
Service, Inc. and BBB 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, 2009, 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 $8.7 million, $6.0 million and $8.4 million in cash
from operations in 2007, 2008 and 2009, respectively. 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 and loss adjustment
expenses of $869,000. These were partially offset by a decrease in unearned
premiums of $2.7 million. The cash provided by operations in 2009 included
an increase in unpaid losses and loss adjustment expenses of $5.9 million,
an increase in premiums payable of $1.8 million, an increase in policyholder
deposits of $1.3 million, an increase in accrued taxes and other payables of
$814,000, and a decrease in premiums receivable of $745,000. These were
partially offset by an increase in reinsurance recoverables on unpaid losses
of $5.6 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 $214,000, $95,000 and $1,527,000 during 2007, 2008
and 2009, respectively, from the sale of investments. NAICO received
proceeds of $17.6 million, $6.7 million and $30.1 million during 2007, 2008
and 2009, 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 increased $2.2 million and $1.9 million in 2007 and 2008
and decreased $532,000 in 2009, 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 3.7 years
and 5.0 years at December 31, 2008 and 2009, respectively.
PAGE 35
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, 2008 and 2009,
Chandler USA had a receivable of $11.9 million and $12.7 million,
respectively, under the Credit Agreement, and Chandler USA earned $881,000,
$590,000 and $388,000 in interest income under the Credit Agreement during
2007, 2008 and 2009, 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, 2009, the total amount of cash and investments
restricted as a result of these arrangements was $8.1 million. In addition,
NAICO has deposited $28.1 million of cash and investments into a trust
account as collateral for a reinsurance agreement in which NAICO is the
assuming reinsurer. During 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.
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 and March 2007, the lease was extended for additional
three year terms, and during March 2010, the lease was extended for an
additional three years with monthly rental installments equal to the sum
of (i) $10,929 plus (ii) interest on the unpaid lease balance at 1% over
JP Morgan Chase Bank prime which was 4.25% at December 31, 2009. The
interest rate is subject to a minimum rate of 5.5% beginning in March 2010.
Chandler USA has the option to repurchase the equipment at the end of the
lease for approximately $1.5 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 $1.2 million. See Note 12 to
Consolidated Financial Statements.
CONTRACTUAL OBLIGATIONS
The following table provides the future payments due by period under
contractual obligations as of December 31, 2009, 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) ....................... $ 46,033 $ 45,917 $ 12,671 $ 2,720 $ 107,341
Future minimum rental payments
under operating leases ............. 368 494 35 - 897
Guaranteed residual value of
operating lease (2) ................ - - 1,199 - 1,199
Capital leases ....................... 50 60 - - 110
Debentures ........................... - - 6,979 - 6,979
Junior subordinated debentures
issued to affiliated trusts ........ - - - 20,620 20,620
---------- --------- --------- --------- ---------
Total .............................. $ 46,451 $ 46,471 $ 20,884 $ 23,340 $ 137,146
========== ========= ========= ========= =========
- ----------------------------------------
<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.
PAGE 36
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.
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
December 31, 2008 and December 31, 2009.
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, 2009, 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, 2009, approximately
96% of total fixed maturity investments were rated AA or better by Moody's
Investor Service, Inc. or Standard & Poor's. Approximately 3% of total fixed
maturities were rated A by Moody's Investor Service, Inc. or by Standard &
Poor's, and approximately 1% was rated BAA by Moody's Investor Service, Inc.
and BBB by Standard & Poor's. NAICO does not hold any investments classified
as trading account assets or derivative financial instruments.
PAGE 37
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 ----------------------
2008 2009 (bp=basis points) 2008 2009
---------- ---------- ----------------- ---------- ----------
(Dollars in thousands) (Dollars in thousands)
Fixed-maturity investments ... $ 77,096 $ 103,221 100 bp increase $ 74,603 $ 99,174
200 bp increase 72,247 95,538
100 bp decrease 78,678 107,144
200 bp decrease 81,410 111,514
The table above illustrates, for example, that an instantaneous 200 basis
point increase in market interest rates at December 31, 2009 would reduce the
estimated fair value of NAICO's fixed-maturity investments by approximately
$7.7 million at that date.
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, 2008 and 2009, 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, 2008 and 2009. 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 ----------------------
2008 2009 price change 2008 2009
---------- ---------- ----------------- ---------- ----------
(Dollars in thousands) (Dollars in thousands)
Equity securities ........ $ 76 $ 42 20% increase .... $ 91 $ 50
20% decrease .... 61 34
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, 2009, the fair value of Chandler
USA's Debentures was estimated to be $7.1 million based on an analytically
determined valuation from an independent rating organization. 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
4.38% at December 31, 2009. At December 31, 2009, the fair value of
Chandler USA's junior subordinated debentures was estimated to be $22.0
million.
PAGE 38
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 and March 2007, the lease was extended for additional three year
terms, and during March 2010, the lease was extended for an additional three
years with monthly rental installments equal to the sum of (i) $10,929 plus
(ii) interest on the unpaid lease balance at 1% over JP Morgan Chase Bank
prime, which was 4.25% at December 31, 2009. The interest rate is subject
to a minimum rate of 5.5% beginning in March 2010. Chandler USA has the
option to repurchase the equipment at the end of the lease for approximately
$1.5 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 $1.2 million.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See Item 15(a)1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
ITEM 9A(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, 2009.
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 64 Chairman of the Board, Chief Executive Officer, Compensation
Committee Member and Director.
Mark T. Paden 53 President, Compensation Committee Member and Director.
Lance A. LaGere 29 Executive Vice President and Chief Operating Officer.
Richard L. Evans 63 Senior Vice President and Director.
R. Patrick Gilmore 58 Senior Vice President, Secretary, General Counsel and Director.
Mark C. Hart 54 Senior Vice President-Finance, Chief Financial Officer and Treasurer.
M. Steven Blain 52 Vice President.
Robert L. Rice 75 Audit Committee Chairman and Director.
W. Scott Martin 59 Audit Committee Member and Director.
William T. Keele 73 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 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.
DIRECTOR QUALIFICATIONS
The preceding paragraphs provide information about each director of
Chandler USA, including the director's particular business experience,
qualifications, directorships for the past five years, and attributes or
skills that led our Board of Directors and sole shareholder to conclude
that they should serve as a director of Chandler USA.
The Board of Directors consists of a total of seven individuals, including
four directors who are also employees, and three non-employee directors.
The current members who are also employees are our Chief Executive Officer
who also serves as our Chairman of the Board, our President, our Senior Vice
President and General Counsel, and our Senior Vice President of Claims. Our
three non-employee directors include a certified public accountant who serves
as Chairman of our Audit Committee, a member who is primarily involved in the
banking industry and a member who is President of a construction and steel
fabrication firm. Each director has more than twenty years of business
experience.
Since Chandler USA's sole shareholder is Chandler Insurance, we do not have
a director nominating committee. Directors are nominated and elected by our
sole shareholder.
BOARD LEADERSHIP STRUCTURE AND RISK OVERSIGHT
Chandler USA's Chairman of the Board is also our Chief Executive Officer.
We believe that this structure is the most appropriate structure for Chandler
USA based on the business experience of our Chairman, Mr. W. Brent LaGere,
his knowledge of our industry, and our ownership structure which is described
in Item 12 "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS." We have not designated a lead independent
director.
Management is primarily responsible for assessing and managing our exposure
to risk. Our Audit Committee, which is comprised of our three non-employee
directors, meets regularly with our independent auditors and our independent
actuary to review our financial condition and to discuss operations. The
Audit Committee regularly reports to our full Board of Directors, which also
considers our exposure to various risks.
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.
PAGE 41
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, 2009.
ITEM 11. EXECUTIVE COMPENSATION.
GENERAL
We believe that our compensation policies and practices for all employees,
including non-executive officers, do not create risks that are reasonably
likely to have a material adverse effect on Chandler USA. We have not
engaged or paid compensation consultants.
COMPENSATION DISCUSSION AND ANALYSIS
This section provides information regarding the compensation of our Chief
Executive Officer, Chief Financial Officer and, in addition, our three most
highly compensated executive officers. Collectively, we refer to these
executives as the named executive officers. Our executive compensation
program is developed and monitored by our Compensation Committee which
consists of our Chief Executive Officer and our President.
COMPENSATION PROGRAM OBJECTIVES
Our overall goal in compensating executive officers is to attract, retain
and motivate key executives who are critical to our future success. We want
to reinforce our goal to grow our business profitably and to reward each
executive's contributions toward this goal. Our decisions with respect to
executive officer salaries and incentives are influenced by the executive's
level of responsibility and function within Chandler USA as well as the
overall performance and profitability of Chandler USA.
EXECUTIVE COMPENSATION ELEMENTS
Our Compensation Committee reviews the performance results of each named
executive officer and establishes individual compensation levels. Our
executive compensation program consists of base salaries, cash bonuses and
perquisites.
BASE SALARIES
The purpose of the base salary is to reflect each executive's job
responsibilities and to reward each executive's job performance. During
2009, the following base salaries were approved for our named executive
officers:
PERCENTAGE
NAMED EXECUTIVE OFFICER 2009 BASE SALARY INCREASE
------------------------------------ ---------------- ----------
W. Brent LaGere .................... $ 589,360 -%
Mark T. Paden ...................... 364,659 3.0%
Richard L. Evans ................... 302,760 3.0%
R. Patrick Gilmore ................. 263,695 -%
Mark C. Hart ....................... 182,586 -%
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.
PAGE 42
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 2009, 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 43
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 2009 $ 589,360 $ 443,811 $ 606,186 $ 1,639,357
and CEO 2008 566,419 735,482 608,574 1,910,475
2007 549,255 504,777 1,432,763 2,486,795
Mark T. Paden, President 2009 363,774 159,000 137,369 660,143
2008 353,178 132,000 105,171 590,349
2007 342,891 183,000 155,994 681,885
Richard L. Evans, Senior 2009 302,025 3,445 23,999 329,469
Vice President - Claims 2008 293,229 - 25,808 319,037
2007 284,688 8,000 22,972 315,660
R. Patrick Gilmore, Senior Vice President, 2009 263,695 - 14,993 278,688
Secretary and General Counsel 2008 258,574 25,000 14,169 297,743
2007 251,043 8,000 14,867 273,910
Mark C. Hart, Senior Vice President - Finance, 2009 182,586 - 6,600 189,186
Chief Financial Officer and Treasurer 2008 180,592 - 6,225 186,817
2007 175,332 15,000 6,225 196,557
- -------------------------------------------------------
<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 ......... 2009 $ 6,600 $ 100,280 $ 251,603 $ 247,703 $ 606,186
2008 6,225 82,075 267,528 252,746 608,574
2007 6,225 100,280 729,179 597,079 1,432,763
Mark T. Paden ........... 2009 6,600 2,500 78,326 49,943 137,369
2008 6,225 3,900 53,425 41,621 105,171
2007 6,225 15,882 72,953 60,934 155,994
Richard L. Evans ........ 2009 6,600 5,000 8,786 3,613 23,999
2008 6,225 5,000 12,219 2,364 25,808
2007 6,225 5,000 8,111 3,636 22,972
R. Patrick Gilmore ...... 2009 6,600 2,100 4,927 1,366 14,993
2008 6,225 1,900 5,146 898 14,169
2007 6,225 2,000 5,188 1,454 14,867
Mark C. Hart ............ 2009 6,600 - - - 6,600
2008 6,225 - - - 6,225
2007 6,225 - - - 6,225
- ----------------------------------
<FN>
(1) The amounts shown in this column reflect company matching contributions under our 401(k) plan.
(2) The amounts shown in this column reflect the premiums paid or to be paid under life insurance
arrangements with the named executive officers. A portion of the premiums for each year
($30,153 for Mr. LaGere, $2,500 for Mr. Paden, $5,000 for Mr. Evans and $2,100 for Mr. Gilmore
during 2009) 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 44
(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 2009 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
and related 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, payments related to personally owned watercraft, payments for miscellaneous
personal expenses and personal flights on company provided aircraft. Mr. LaGere's personal expenses
also included estate planning services, payments for home improvements and payments for personal
charges on personal credit cards of $145,936 during 2009. 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 ................... 2009 $ 13,125 $ 13,125
2008 13,125 13,125
2007 12,375 12,375
W. Scott Martin .................. 2009 11,250 11,250
2008 11,250 11,250
2007 11,250 11,250
William T. Keele ................. 2009 10,750 10,750
2008 11,250 11,250
2007 11,250 11,250
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 2, 2010 Compensation Committee:
W. Brent LaGere
Mark T. Paden
PAGE 45
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, 2010, 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 18.1%
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 13.4%
Richard L. Evans ........................................... Series C Preferred Shares 937 0.2%
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 22.8%
- -------------------------------------------------------------
<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 624,569 Series C Preferred Shares of Chandler Insurance
outstanding on February 28, 2010.
(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 46
(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, 2010. 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 13.4%
- --------------------------------------------------------------------
<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 624,569 Series C Preferred Shares of Chandler Insurance
outstanding on February 28, 2010.
(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 47
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 and March 2007, the lease was extended for additional three
year terms, and during March 2010 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 $50,000 as of December 31, 2009.
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 2007, 2008 and 2009, Chandler USA
incurred approximately $302,000, $361,000 and $332,000, respectively, in
expenses associated with its use of this property, including $3,000, $4,000
and $4,000 for reimbursement of certain expenses, such as utility and similar
expenses, for the years 2007, 2008 and 2009, respectively.
DIRECTOR INDEPENDENCE
Chandler USA is a privately held corporation with only debt securities
listed on the NYSE Amex LLC ("NYSE Amex") exchange (formerly known as the
American Stock Exchange). NYSE Amex requires that a majority of the directors
be "independent directors" as defined in the NYSE Amex'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 ACCOUNTING 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 $195,800 and $202,800 for the years ended
December 31, 2008 and 2009, 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 $19,500 and $20,000 for the years ended December 31, 2008
and 2009, respectively.
PAGE 48
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 $46,670 and $36,400 for the years ended December 31, 2008 and 2009,
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, 2008 and 2009.
POLICY ON PRE-APPROVAL OR RETENTION OF INDEPENDENT AUDITORS
All audit and permitted non-audit services for which Chandler USA engages
HoganTaylor 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 HoganTaylor LLP was 25.3% and 21.7% for the years ended
December 31, 2008 and 2009, 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, 2008 and 2009, 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, 2009, 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 49
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 50
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 2, 2010 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 2, 2010 /s/ W. Brent LaGere
----------------------------------------------------
W. Brent LaGere, Chairman of the Board,
Chief Executive Officer and Director
(Principal Executive Officer)
Date: March 2, 2010 /s/ Mark T. Paden
----------------------------------------------------
Mark T. Paden, President and Director
Date: March 2, 2010 /s/ Mark C. Hart
----------------------------------------------------
Mark C. Hart, Senior Vice President - Finance,
Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer)
Date: March 2, 2010 /s/ Richard L. Evans
----------------------------------------------------
Richard L. Evans, Senior Vice President and Director
Date: March 2, 2010 /s/ R. Patrick Gilmore
----------------------------------------------------
R. Patrick Gilmore, Senior Vice President,
Secretary, General Counsel and Director
Date: March 2, 2010 /s/ Robert L. Rice
----------------------------------------------------
Robert L. Rice, Director
Date: March 2, 2010 /s/ W. Scott Martin
----------------------------------------------------
W. Scott Martin, Director
Date: March 2, 2010 /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, 2008 and 2009 ................................. F-2
Consolidated Statements of Operations for the years ended
December 31, 2007, 2008 and 2009 ........................................................... F-3
Consolidated Statements of Comprehensive Income for the years ended
December 31, 2007, 2008 and 2009 ........................................................... F-4
Consolidated Statements of Cash Flows for the years ended
December 31, 2007, 2008 and 2009 ........................................................... F-5
Consolidated Statements of Shareholder's Equity for the years ended
December 31, 2007, 2008 and 2009 ........................................................... F-6
Notes to Consolidated Financial Statements ................................................... F-7 through F-29
Report of Independent Registered Public Accounting Firm on Consolidated Financial Statements
and Financial Statement Schedules .......................................................... F-30
SCHEDULES
I Summary of Investments - Other Than Investments in Related Parties ................... F-31
II Condensed Financial Information of Registrant ........................................ F-32 through F-34
III Supplementary Insurance Information .................................................. F-35
IV Reinsurance .......................................................................... F-36
V Valuation and Qualifying Accounts .................................................... F-37
VI Supplemental Information (Concerning Property-Casualty Insurance Operations) ......... F-38
PAGE F-2
CHANDLER (U.S.A.), INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands except share amounts)
DECEMBER 31,
-----------------------
2008 2009
---------- ----------
ASSETS
Investments
Fixed maturities available for sale, at fair value
Restricted (amortized cost $34,243 and $34,923 in 2008 and 2009, respectively) ......... $ 35,397 $ 35,392
Unrestricted (amortized cost $40,771 and $66,735 in 2008 and 2009, respectively) ....... 41,699 67,829
Equity securities at fair value (cost $0 in 2008 and 2009) ............................... 76 42
Short-term investments at fair value (amortized cost $5,853 and $380 in 2008
and 2009, respectively) ................................................................ 5,865 380
---------- ----------
Total investments ...................................................................... 83,037 103,643
Cash and cash equivalents ($118 and $2,194 restricted in 2008 and 2009, respectively) ...... 20,636 7,430
Accrued investment income .................................................................. 1,018 1,228
Premiums receivable, less allowance for non-collection of $138 and $291 at
2008 and 2009, respectively .............................................................. 26,405 25,305
Reinsurance recoverable on paid losses ..................................................... 423 316
Reinsurance recoverable on unpaid losses, less allowance for non-collection
of $231 and $298 at 2008 and 2009, respectively .......................................... 32,492 36,588
Reinsurance recoverable on unpaid losses from related parties .............................. 19,899 21,360
Prepaid reinsurance premiums ............................................................... 2,882 3,424
Prepaid reinsurance premiums to related parties ............................................ 12,203 12,276
Deferred policy acquisition costs .......................................................... 1,304 1,546
Property and equipment, net ................................................................ 7,849 7,174
Amounts due from related parties ........................................................... 11,869 12,697
State insurance licenses, net .............................................................. 3,745 3,745
Other assets ............................................................................... 10,885 10,613
---------- ----------
Total assets ............................................................................... $ 234,647 $ 247,345
========== ==========
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Unpaid losses and loss adjustment expenses ............................................... $ 101,459 $ 107,341
Unearned premiums ........................................................................ 43,725 44,519
Policyholder deposits .................................................................... 7,820 9,094
Accrued taxes and other payables ......................................................... 6,017 6,831
Premiums payable ......................................................................... 2,440 4,266
Premiums payable to related parties ...................................................... 222 522
Debentures ............................................................................... 6,979 6,979
Junior subordinated debentures issued to affiliated trusts ............................... 20,620 20,620
---------- ----------
Total liabilities ...................................................................... 189,282 200,172
---------- ----------
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 ...................................................................... (16,654) (14,472)
Accumulated other comprehensive income:
Unrealized gain on investments available for sale, net of deferred income taxes ........ 1,433 1,059
---------- ----------
Total shareholder's equity ............................................................. 45,365 47,173
---------- ----------
Total liabilities and shareholder's equity ................................................. $ 234,647 $ 247,345
========== ==========
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,
--------------------------------------
2007 2008 2009
------------ ------------ ------------
Premiums and other revenues
Direct premiums written and assumed ................................... $ 100,081 $ 98,384 $ 91,185
Reinsurance premiums ceded ............................................ (7,690) (9,476) (10,653)
Reinsurance premiums ceded to related parties ......................... (27,959) (26,596) (23,994)
------------ ------------ ------------
Net premiums written and assumed .................................... 64,432 62,312 56,538
Decrease (increase) in unearned premiums .............................. 1,753 1,715 (178)
------------ ------------ ------------
Net premiums earned ................................................. 66,185 64,027 56,360
Investment income (loss), net ........................................... (572) 3,347 3,168
Interest income, net from related parties ............................... 941 647 438
Realized investment gains, net .......................................... 214 95 1,527
Other income ............................................................ 1,916 2,069 2,037
------------ ------------ ------------
Total premiums and other revenues ................................... 68,684 70,185 63,530
------------ ------------ ------------
Operating costs and expenses
Losses and loss adjustment expenses, net of amounts ceded
to related parties of $16,808, $15,532 and $14,791
in 2007, 2008 and 2009, respectively ................................ 41,393 40,940 34,214
Policy acquisition costs, net of ceding commissions received
from related parties of $10,633, $10,112 and $9,123
in 2007, 2008 and 2009, respectively ................................ 12,547 12,348 12,044
General and administrative expenses ................................... 12,790 13,124 11,437
Interest expense ...................................................... 2,703 2,569 2,357
------------ ------------ ------------
Total operating costs and expenses .................................. 69,433 68,981 60,052
------------ ------------ ------------
Income (loss) before income taxes ....................................... (749) 1,204 3,478
Federal income tax benefit (provision) .................................. 87 (679) (1,296)
------------ ------------ ------------
Income (loss) ........................................................... $ (662) $ 525 $ 2,182
============ ============ ============
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,
--------------------------------------
2007 2008 2009
------------ ------------ ------------
Net income (loss) ........................................................... $ (662) $ 525 $ 2,182
------------ ------------ ------------
Other comprehensive income (loss), before income tax:
Unrealized gains on securities:
Unrealized holding gains arising during period ............................ 2,187 1,968 961
Less: Reclassification adjustment for gains included in net income (loss).. (214) (95) (1,527)
------------ ------------ ------------
Other comprehensive income (loss), before income tax ........................ 1,973 1,873 (566)
Income tax benefit (provision) related to items of other
comprehensive income (loss) ................................................ (671) (637) 192
------------ ------------ ------------
Other comprehensive income (loss), net of income tax ........................ 1,302 1,236 (374)
------------ ------------ ------------
Comprehensive income ........................................................ $ 640 $ 1,761 $ 1,808
============ ============ ============
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,
--------------------------------------
2007 2008 2009
------------ ------------ ------------
OPERATING ACTIVITIES
Net income (loss) ..................................................... $ (662) $ 525 $ 2,182
Add (deduct):
Adjustments to reconcile net income (loss) to cash
provided by operating activities:
Realized investment gains, net .................................... (214) (95) (1,527)
Net (gains) losses on sale of property and equipment .............. (6) 7 34
Amortization and depreciation ..................................... 1,431 1,555 1,866
Provision for non-collection of premiums .......................... 19 30 355
Provision for non-collection of reinsurance recoverables .......... 356 166 179
Provision for non-collection of debenture ......................... - 262 40
Net change in non-cash balances relating to operating activities:
Accrued investment income ....................................... 4,148 (144) (210)
Premiums receivable ............................................. 2,861 1,693 745
Reinsurance recoverable on paid losses .......................... (260) 503 (5)
Reinsurance recoverable on unpaid losses ........................ (10,557) 3,552 (4,163)
Reinsurance recoverable on unpaid losses from related parties ... (3,104) (1,211) (1,461)
Prepaid reinsurance premiums .................................... 4,498 223 (542)
Prepaid reinsurance premiums to related parties ................. 578 725 (73)
Deferred policy acquisition costs ............................... (273) (186) (242)
Other assets .................................................... (1,373) (156) 367
Unpaid losses and loss adjustment expenses ...................... 17,337 869 5,882
Unearned premiums ............................................... (6,828) (2,664) 794
Policyholder deposits ........................................... 284 (127) 1,274
Accrued taxes and other payables ................................ 997 240 814
Premiums payable ................................................ 308 177 1,826
Premiums payable to related parties ............................. (804) 24 300
------------ ------------ ------------
Cash provided by operating activities ............................. 8,736 5,968 8,435
------------ ------------ ------------
INVESTING ACTIVITIES
Short-term investments:
Purchases ........................................................... (1,330) (6,424) (380)
Maturities .......................................................... 285 1,615 5,850
Unrestricted fixed maturities available for sale:
Purchases ........................................................... (13,585) (38,722) (64,552)
Sales ............................................................... 10,120 6,417 30,104
Maturities .......................................................... 8,588 19,682 8,405
Equity securities available for sale:
Purchases ........................................................... (5,811) (266) -
Sales ............................................................... 7,457 270 -
Cost of property and equipment purchased .............................. (696) (642) (266)
Proceeds from sale of property and equipment .......................... 50 145 27
------------ ------------ ------------
Cash provided by (applied to) investing activities ................ 5,078 (17,925) (20,812)
------------ ------------ ------------
FINANCING ACTIVITIES
Payments and loans from related parties ............................... 2,164 2,639 2,292
Payments and loans to related parties ................................. (4,086) (3,002) (3,121)
Payments on bank loan ................................................. (339) - -
------------ ------------ ------------
Cash applied to financing activities .............................. (2,261) (363) (829)
------------ ------------ ------------
Increase (decrease) in cash and cash equivalents during the period .... 11,553 (12,320) (13,206)
Cash and cash equivalents at beginning of period ...................... 21,403 32,956 20,636
------------ ------------ ------------
Cash and cash equivalents at end of period ............................ $ 32,956 $ 20,636 $ 7,430
============ ============ ============
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, 2007 ......... $ 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
----------- ----------- ----------- ------------- -------------
Net income ....................... - - 2,182 - 2,182
Change in unrealized gain on
investments available for
sale, net of income tax ......... - - - (374) (374)
----------- ----------- ----------- ------------- -------------
Balance, December 31, 2009 ....... $ 2 $ 60,584 $ (14,472) $ 1,059 $ 47,173
=========== =========== =========== ============= =============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
PAGE F-7
CHANDLER (U.S.A.), INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2007, 2008 AND 2009
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.
Amortization of deferred policy acquisition costs was approximately
$5.9 million in 2007, and $5.5 million in 2008 and 2009, respectfully.
(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:
2008 2009
---------- ----------
(In thousands)
Real estate and improvements ... $ 12,058 $ 12,106
Other property and equipment ... 8,803 8,743
---------- ----------
20,861 20,849
Accumulated depreciation ....... (13,012) (13,675)
---------- ----------
$ 7,849 $ 7,174
========== ==========
Depreciation expense was approximately $854,000, $896,000 and
$881,000 for 2007, 2008 and 2009, 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 2008 and 2009 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:
2008 2009
---------- ----------
(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,
--------------------------------
2007 2008 2009
---------- ---------- ----------
(In thousands)
Cash payments during the year for:
Interest ....................................... $ 2,649 $ 2,517 $ 2,377
Income taxes, net of refunds received .......... 25 1,220 640
Transfers from (to) restricted securities, net ... $ (12,726) $ (1,619) $ 750
(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
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 2 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 3 for the required disclosures.
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.
PAGE F-11
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 will adopt this new guidance effective
January 1, 2010. This new guidance will have no impact on Chandler
USA's consolidated financial statements. While the trusts that
hold Chandler USA's junior subordinated debentures are variable
interest entities, and Chandler USA has 100% ownership, complete
voting control and has guaranteed the performance of the trusts,
Chandler USA is not the primary beneficiary because its interest is
not variable. Therefore, Chandler USA will not consolidate the
trusts under the new guidance.
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. Chandler USA has
adopted this new guidance as of October 1, 2009. The adoption of
this new guidance did not have any impact on its consolidated
financial statements.
NOTE 2. 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.
PAGE F-12
The following tables present information about Chandler USA's assets
measured at fair value on a recurring basis as of December 31, 2008 and 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 December 31, 2008 or 2009.
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:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies ............. $ - $ 41,500 $ - $ 41,500
Corporate obligations .............................. - 29,485 - 29,485
Public utilities ................................... - 2,976 - 2,976
Obligations of states and political subdivisions ... - 3,135 - 3,135
---------------- --------------- ---------------- -----------
Total fixed maturities available for sale ........ - 77,096 - 77,096
Equity securities - corporate stock .................. - - 76 76
Short-term investments ............................... - 5,865 - 5,865
---------------- --------------- ---------------- -----------
Total .............................................. $ - $ 82,961 $ 76 $ 83,037
================ =============== ================ ===========
Fair value measurements at December 31, 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:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies ............. $ - $ 41,074 $ - $ 41,074
Corporate obligations .............................. - 32,591 - 32,591
Public utilities ................................... - 2,095 - 2,095
Obligations of states and political subdivisions ... - 27,461 - 27,461
---------------- --------------- ---------------- -----------
Total fixed maturities available for sale ........ - 103,221 - 103,221
Equity securities - corporate stock .................. - - 42 42
Short-term investments ............................... - 380 - 380
---------------- --------------- ---------------- -----------
Total .............................................. $ - $ 103,601 $ 42 $ 103,643
================ =============== ================ ===========
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 and $377,000 at December 31, 2008 and 2009, respectively, or 0.5%
and 0.4% of total Level 2 assets. There were no transfers of assets into
or out of Level 1 or Level 2 during 2009.
PAGE F-13
At December 31, 2008 and 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 years ended December 31, 2008 and 2009.
Fair value measurements using significant Year ended Year ended
unobservable inputs (Level 3) December 31, 2008 December 31, 2009
------------------------------------------------- ----------------- -----------------
(In thousands)
Equity Securities - corporate stocks:
Beginning balance ............................. $ 141 $ 76
Total realized and unrealized gains (losses):
Included in earnings ...................... - -
Included in other comprehensive income .... (65) (34)
Purchases, issuances, sales and settlements:
Purchases ................................. - -
Issuances ................................. - -
Sales ..................................... - -
Settlements ............................... - -
Transfers into Level 3 .................... - -
Transfers out of Level 3 .................. - -
----------------- -----------------
Ending balance ................................ $ 76 $ 42
================= =================
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,
--------------------------------
2007 2008 2009
---------- ---------- ----------
(In thousands)
Interest on fixed-maturity investments ................... $ 2,818 $ 2,929 $ 3,299
Interest on short-term investments and cash equivalents .. 1,069 692 111
Dividend income on equity securities ..................... 11 1 -
Prejudgment interest related to litigation ............... (4,148) - -
Investment expenses ...................................... (322) (275) (242)
---------- ---------- ----------
Investment income, net ................................. (572) 3,347 3,168
---------- ---------- ----------
Realized gains, net - fixed-maturity investments ......... 154 91 1,527
Realized gains, net - equity securities .................. 60 4 -
---------- ---------- ----------
Realized investment gains, net ......................... 214 95 1,527
---------- ---------- ----------
$ (358) $ 3,442 $ 4,695
========== ========== ==========
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 $193,000, $128,000 and $91,000 for the years
ended December 31, 2007, 2008 and 2009, respectively, in expense to subsidize
a premium finance program for certain insureds of NAICO with an unaffiliated
premium finance company.
PAGE F-14
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, 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
========== ========== ========== ========== ==========
GROSS GROSS
UNREALIZED UNREALIZED FAIR CARRYING
DECEMBER 31, 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 ................................... $ 40,395 $ 731 $ (52) $ 41,074 $ 41,074
Corporate obligations ............................. 31,989 732 (130) 32,591 32,591
Public utilities .................................. 2,052 43 - 2,095 2,095
Obligations of states and political subdivisions... 27,222 331 (92) 27,461 27,461
---------- ---------- ---------- ---------- ----------
$ 101,658 $ 1,837 $ (274) $ 103,221 $ 103,221
========== ========== ========== ========== ==========
EQUITY SECURITIES:
Corporate stock ................................... $ - $ 42 $ - $ 42 $ 42
========== ========== ========== ========== ==========
Chandler USA held investments in fixed maturities issued by General Electric
Capital Corporation with a fair value of $4.6 million at December 31, 2008 and
2009, or 10.1% and 9.8% of shareholder's equity, respectively. 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 December 31, 2008
or 2009.
The fair value of Chandler USA's investments with continuous gross
unrealized losses at December 31, 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 .......... $ 8,886 $ (52) $ - $ - $ 8,886 $ (52)
Corporate securities ................. 2,505 (130) - - 2,505 (130)
Public utilities ..................... - - - - - -
Obligations of states and political
subdivisions ....................... 9,866 (91) 153 (1) 10,019 (92)
----------- ---------- ----------- ---------- ----------- ----------
$ 21,257 $ (273) $ 153 $ (1) $ 21,410 $ (274)
=========== ========== =========== ========== =========== ==========
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, 2009.
PAGE F-15
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, 2009 are shown below:
AVAILABLE FOR SALE
------------------------
AMORTIZED
COST FAIR VALUE
------------ ----------
(In thousands)
Due in one year or less .......................... $ 7,658 $ 7,768
Due after one year through five years ............ 51,274 52,505
Due after five years through ten years ........... 37,443 37,636
Due after ten years .............................. 5,283 5,312
------------ ----------
$ 101,658 $ 103,221
============ ==========
Realized gains and losses from sales of investments are shown below:
2007 2008 2009
-------- -------- --------
(In thousands)
FIXED MATURITIES:
Gross realized gains ............................. $ 191 $ 148 $ 1,527
Gross realized losses ............................ (37) (57) -
-------- -------- --------
Total net realized gains ........................ $ 154 $ 91 $ 1,527
======== ======== ========
EQUITY SECURITIES:
Gross realized gains ............................. $ 229 $ 4 $ -
Gross realized losses ............................ (169) - -
-------- -------- --------
Total net realized gains ........................ $ 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, 2008 and 2009, the carrying value of these deposits totaled approximately
$8.6 million and $8.1 million, respectively. In addition, at December 31,
2008 and 2009, NAICO had deposited $27.0 million and $28.1 million of cash
and investments into a trust account as collateral for a reinsurance agreement
in which NAICO is the assuming reinsurer. During 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.
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 $10.9 million and $10.8 million at December 31, 2008 and 2009,
respectively. Included in these recoverable amounts were net recoverables
of $10.1 million in 2008 and 2009, 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-16
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,
----------------------------------
2007 2008 2009
---------- ---------- ----------
(In thousands)
Net balance at beginning of year .......................... $ 42,081 $ 45,866 $ 49,068
---------- ---------- ----------
Net losses and loss adjustment expenses incurred related to:
Current year ............................................ 40,194 38,869 33,480
Prior years ............................................. 1,199 2,071 734
---------- ---------- ----------
Total ................................................. 41,393 40,940 34,214
---------- ---------- ----------
Net paid losses and loss adjustment expenses related to:
Current year ............................................ (12,494) (11,856) (10,531)
Prior years ............................................. (25,114) (25,882) (23,358)
---------- ---------- ----------
Total ................................................. (37,608) (37,738) (33,889)
---------- ---------- ----------
Net balance at end of year ................................ $ 45,866 $ 49,068 $ 49,393
========== ========== ==========
NAICO experienced incurred losses related to prior accident years totaling
$1.2 million, $2.1 million and $734,000 during 2007, 2008 and 2009,
respectively. 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 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.
During 2009, NAICO experienced adverse loss development totaling
$734,000 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 and other
liability lines of business in this program. The adverse loss
development included approximately $180,000 for provisions for
potentially uncollectible reinsurance.
PAGE F-17
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.
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, 2009, there were $6,979,000 principal
amount of the Debentures outstanding. As of December 31, 2009, Chandler USA
has capitalized $149,000 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, 2009, 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-18
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 4.38% at
December 31, 2009. 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 4.38% at December
31, 2009. 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, 2009, issuance costs in the
amount of $573,000 have been capitalized and are being amortized over the
stated maturity periods of thirty years.
Trust I and Trust II are variable interest entities in which Chandler USA
is not the primary beneficiary under GAAP because its interest is not
variable. Therefore, Chandler USA is prohibited from consolidating these
trusts even though it has 100% ownership, complete voting control and has
guaranteed the performance of the trusts. Accordingly, Chandler USA
carries the Junior Debentures I and Junior Debentures II as a liability on
its consolidated balance sheets.
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:
2007 2008 2009
-------- -------- --------
(In thousands)
Statutory net income .............. $ 1,037 $ 2,375 $ 3,602
Statutory capital and surplus ..... $ 50,250 $ 51,069 $ 54,111
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
$305,000, $251,000 and $160,000 at December 31, 2007, 2008 and 2009,
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-19
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, 2008 and 2009.
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 $5.4
million. NAICO paid cash shareholder dividends to Chandler USA totaling $1.6
million, $2.1 million and $1.4 million in 2007, 2008 and 2009, respectively.
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 $15.5 million as of
December 31, 2009). NAICO did not pay any policyholder dividends during 2007,
2008 or 2009.
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:
2007 2008 2009
---------- ---------- ----------
(In thousands)
Computed income tax provision (benefit) at 34% ................... $ (255) $ 409 $ 1,183
Increase (decrease) in income taxes resulting from:
Utilization of capital loss carryforward ....................... (73) - -
Interest income on the exempt securities ....................... - (27) (162)
Nondeductible meals and entertainment expenses ................. 150 174 166
Other nondeductible expenses ................................... 91 123 109
---------- ---------- ----------
Federal income tax provision (benefit) ........................... $ (87) $ 679 $ 1,296
========== ========== ==========
U.S. Federal income tax provision (benefit) consists of:
CURRENT DEFERRED TOTAL
---------- ---------- ----------
(In thousands)
2007 ............................................................. $ - $ (87) $ (87)
2008 ............................................................. 1,074 (395) 679
2009 ............................................................. 1,460 (164) 1,296
PAGE F-20
Deferred income tax provision (benefit) relating to temporary differences
includes the following components:
2007 2008 2009
---------- ---------- ----------
(In thousands)
Loss reserve discounts ........................................... $ 9 $ (57) $ (87)
Unearned premiums ................................................ 119 117 (12)
Deferred policy acquisition costs ................................ 93 63 82
Investment in limited partnerships ............................... (40) (7) (122)
Reserve for uncollectible premiums receivable .................... 12 (2) (52)
Reserve for non-collection of debenture .......................... - (89) (14)
Depreciation and lease expense ................................... (49) (52) 10
Discount on fixed maturity investments ........................... 21 (13) (65)
Accrued commissions payable ...................................... - (261) 108
Accrual of prejudgment interest income ........................... (1,410) - -
Net operating loss carryforwards ................................. 1,118 - -
Other ............................................................ 40 (94) (12)
---------- ---------- ----------
$ (87) $ (395) $ (164)
========== ========== ==========
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:
2008 2009
------------ ------------
(In thousands)
Deferred tax assets:
Loss reserve discounts ...................................... $ 2,098 $ 2,185
Unearned premiums ........................................... 1,948 1,960
Compensated absences ........................................ 231 227
Accrued commissions payable ................................. 261 153
Net operating loss carryforwards - state .................... 2,100 2,032
Investment in limited partnership ........................... 324 447
Reserve for non-collection of debenture ..................... 89 103
Other ....................................................... 337 394
Valuation allowance ......................................... (2,100) (2,032)
------------ ------------
Total deferred tax assets ..................................... 5,288 5,469
------------ ------------
Deferred tax liabilities:
Depreciation and lease expense .............................. 1,200 1,209
Deferred policy acquisition costs ........................... 443 526
Unrealized gain on investments available for sale ........... 738 546
Other ....................................................... 194 119
------------ ------------
Total deferred tax liabilities ................................ 2,575 2,400
------------ ------------
Net deferred tax assets ....................................... $ 2,713 $ 3,069
============ ============
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, 2009, had net operating loss
carryforwards available for Oklahoma state income taxes totaling
approximately $33.9 million which expire in the years 2010 through 2029.
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 2006 through 2009 are open to examination by the U.S. Internal
Revenue Service and the Oklahoma Tax Commission.
PAGE F-21
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 $6,600 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
$288,000, $293,000 and $288,000 for 2007, 2008 and 2009, respectively.
NOTE 10. FAIR VALUE DISCLOSURES OF FINANCIAL INSTRUMENTS
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, 2008 and 2009. The estimated fair values of Chandler USA's
fixed-maturity and equity security investments are disclosed at Note 3. At
December 31, 2009, the fair value of Chandler USA's Debentures was estimated
to be $7.1 million based on an analytically determined valuation from an
independent rating organization. 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, 2009 was 4.38%. At December
31, 2009, the fair value of Chandler USA's junior subordinated debentures
was estimated to be $22.0 million.
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.
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-22
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.
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 December 31, 2008 and December 31, 2009.
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.
NAICO has structured separate reinsurance programs for property (including
inland marine), workers compensation, casualty (including automobile
liability, general and products liability, umbrella liability and related
professional liability), automobile physical damage and construction surety
bonds. Chandler Insurance reinsures NAICO for a portion of the risk on
NAICO's reinsurance programs.
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.
PAGE F-23
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,
2010.
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 2007,
2008 and 2009, NAICO incurred charges of $356,000, $166,000 and $180,000,
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:
2007 2008 2009
----------------------- ----------------------- -----------------------
WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED
----------- ---------- ----------- ---------- ----------- ----------
(In thousands)
Direct ........... $ 85,836 $ 93,487 $ 90,871 $ 91,367 $ 82,234 $ 82,791
Assumed .......... 14,245 13,422 7,513 9,680 8,951 7,600
Ceded ............ (35,649) (40,724) (36,072) (37,020) (34,647) (34,031)
----------- ---------- ----------- ---------- ----------- ----------
Net premiums ..... $ 64,432 $ 66,185 $ 62,312 $ 64,027 $ 56,538 $ 56,360
=========== ========== =========== ========== =========== ==========
NAICO's assumed premiums generally result from certain business produced by
CIMI for other insurance companies that is reinsured by NAICO, and from NAICO's
participation in various mandatory workers compensation pools.
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 $39.5 million,
$28.0 million and $24.7 million for 2007, 2008 and 2009, 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, 2008 and
2009 were $26.4 million and $25.3 million, respectively. Receivables for
deductibles, in most cases, are secured by cash deposits and letters of
credit. At December 31, 2009, NAICO maintained custody of such letters of
credit securing these and other transactions totaling approximately $18.4
million, which is a reasonable estimate of their fair value. These letters
of credit are not reflected in the accompanying consolidated financial
statements. There were no unaffiliated independent insurance agents that
produced 10% or more of NAICO's direct written and assumed premiums during
2007, 2008 or 2009.
PAGE F-24
Approximately $34.5 million, or 47% of NAICO's reinsurance recoverables and
prepaid reinsurance premiums at December 31, 2009 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, 2009.
CEDED REINSURANCE
NET PREMIUMS FOR A.M. BEST
REINSURANCE THE YEAR ENDED COMPANY
NAME OF REINSURER RECOVERABLE (1) DECEMBER 31, 2009 RATING
- ---------------------------------------------------------- --------------- ------------------ -----------
(Dollars in thousands)
Chandler Insurance ....................................... $ 33,636 $ 23,994 (2)
Swiss Reinsurance America Corporation (3)................. 16,448 289 A
Westport Insurance Corporation (3)........................ 8,837 - A
Transatlantic Reinsurance Company ........................ 4,395 2,390 A
Markel Insurance Company ................................. 3,875 1,841 A
--------------- ------------------
Top five reinsurers ................................. $ 67,191 $ 28,514
=============== ==================
All reinsurers ...................................... $ 73,964 $ 34,647
=============== ==================
Percentage of total represented by top five reinsurers ... 91% 82%
- -------------------------------------------------------------
<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, 2009.
(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, 2009, Chandler Insurance had cash and
investments, including accrued interest, with a fair value of $33.1 million deposited in a trust account for the
benefit of NAICO, and also had premiums receivable of $522,000 due from 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 $853,000 and $685,000
at December 31, 2008 and 2009, 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 $2,732,000 and $2,866,000 at December 31, 2008
and 2009, 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-25
At December 31, 2009, Chandler USA's subsidiaries were committed under
noncancellable operating and capital leases for certain equipment and office
space. Rental payments under these leases were $648,000, $617,000 and $518,000
in 2007, 2008 and 2009, respectively. Future minimum lease payments are as
follows:
(In thousands)
2010 .......................... $ 418
2011 .......................... 307
2012 .......................... 241
2013 .......................... 41
2014 .......................... -
--------------
$ 1,007
==============
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 and March 2007, the lease was extended for additional three year
terms, and during March 2010, the lease was extended for an additional three
years with monthly rental installments equal to the sum of (i) $10,929 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, 2009. The
interest rate is subject to a minimum rate of 5.5% beginning in March 2010.
Chandler USA has the option to repurchase the equipment at the end of the
lease for approximately $1.5 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 $1.2 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 and March 2007, the lease was extended for additional
three year terms, and during March 2010 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 $50,000 as of December 31,
2009.
PAGE F-26
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.
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 $302,000, $361,000 and $332,000 in expenses
associated with this property during 2007, 2008 and 2009, respectively,
including $3,000, $4,000 and $4,000 for reimbursement of certain expenses,
such as utility and similar expenses, for the years 2007, 2008 and 2009,
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,
2008 and 2009, Chandler USA had a receivable of $11.9 million and $12.7
million, respectively, under the Credit Agreement, and Chandler USA earned
$881,000, $590,000 and $388,000 in interest income under the Credit
Agreement during 2007, 2008 and 2009, 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.
The agency segment accounted for 7.0%, 6.7% and 6.4% of 2007, 2008 and 2009
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-27
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)
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
2009
Revenues from external customers (1) ...................... $ 56,787 $ 1,610 $ - $ 58,397
Intersegment revenues ..................................... 149 2,604 (2,753) -
Interest income, net ...................................... 3,610 (4) - 3,606
Interest expense .......................................... 2,357 - - 2,357
Segment profit before income taxes (2) .................... 2,742 736 - 3,478
Segment assets ............................................ 245,400 10,139 (8,194) 247,345
Depreciation and amortization ............................. 1,866 - - 1,866
- ---------------------------------------------------
<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:
2007 2008 2009
-------- -------- --------
(In thousands)
Segment asset eliminations
Investment in subsidiaries ............................. $ 1 $ 1 $ 1
Elimination of intersegment receivables ................ 5,886 7,478 8,193
-------- -------- --------
$ 5,887 $ 7,479 $ 8,194
======== ======== ========
PAGE F-28
Net premiums earned and losses and loss adjustment expenses within the
property and casualty segment can be identified to Chandler USA designated
insurance programs and lines of business. 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 and line 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 and lines of business
are offered. Certain discrete financial information is not readily available
by insurance program or line of business, including assets, interest income,
and investment gains or losses. Chandler USA does not consider its insurance
programs and lines of business to be reportable segments, however, the
following supplemental information for net premiums earned and losses and
loss adjustment expenses pertaining to each insurance program and line of
business is presented for the property and casualty segment.
YEAR ENDED DECEMBER 31,
----------------------------------
INSURANCE PROGRAM 2007 2008 2009
- ---------------------------------------------------------- ---------- ---------- ----------
(In thousands)
NET PREMIUMS EARNED
Standard lines ........................................... $ 62,342 $ 61,047 $ 54,129
Political subdivisions ................................... 3,436 2,747 1,925
Homeowners ............................................... 9 - -
Surety bonds ............................................. 186 83 70
Other .................................................... 212 150 236
---------- ---------- ----------
$ 66,185 $ 64,027 $ 56,360
========== ========== ==========
LOSSES AND LOSS ADJUSTMENT EXPENSES
Standard lines ........................................... $ 37,122 $ 38,897 $ 31,629
Political subdivisions ................................... 1,584 1,860 1,564
Homeowners ............................................... (48) 34 2
Surety bonds ............................................. 2,082 (43) 493
Other .................................................... 653 192 526
---------- ---------- ----------
$ 41,393 $ 40,940 $ 34,214
========== ========== ==========
YEAR ENDED DECEMBER 31,
----------------------------------
LINES OF INSURANCE 2007 2008 2009
- ---------------------------------------------------------- ---------- ---------- ----------
(In thousands)
NET PREMIUMS EARNED
Workers compensation ..................................... $ 17,861 $ 20,681 $ 21,267
Automobile liability ..................................... 26,469 21,537 16,816
Other liability .......................................... 15,137 16,301 12,826
Automobile physical damage ............................... 6,096 5,492 4,995
Other .................................................... 622 16 456
---------- ---------- ----------
$ 66,185 $ 64,027 $ 56,360
========== ========== ==========
LOSSES AND LOSS ADJUSTMENT EXPENSES
Workers compensation ..................................... $ 11,107 $ 15,558 $ 16,703
Automobile liability ..................................... 19,503 15,207 11,349
Other liability .......................................... 4,901 6,078 3,458
Automobile physical damage ............................... 3,354 4,114 2,517
Other .................................................... 2,528 (17) 187
---------- ---------- ----------
$ 41,393 $ 40,940 $ 34,214
========== ========== ==========
PAGE F-29
NOTE 15. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
A summary of the unaudited quarterly operating results during 2008 and 2009
follows:
First Second Third Fourth Total
quarter quarter quarter quarter year
--------- --------- --------- --------- --------
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
2009
- -----------------------------------------------------
Net premiums earned ................................ $ 14,869 $ 14,209 $ 13,257 $ 14,025 $56,360
Investment income, net ............................. 867 889 949 901 3,606
Realized investment gains, net ..................... 384 805 194 144 1,527
Income before income taxes ......................... 1,682 543 961 292 3,478
Net income ......................................... 1,071 325 596 190 2,182
* * * * * * *
PAGE F-30
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholder of
Chandler (U.S.A.), Inc.:
We have audited the accompanying consolidated balance sheets of Chandler
(U.S.A.), Inc. and subsidiaries ("Chandler USA") as of December 31, 2008 and
2009, 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, 2009. 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 USA for the year 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
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Chandler
USA as of December 31, 2008 and 2009, and the results of its operations and
its cash flows for each of the three years in the period ended December 31,
2009 in conformity with U.S. generally accepted accounting principles. Also,
in our opinion, the related 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, 2009 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 30, 2010
PAGE F-31
SCHEDULE I
CHANDLER (U.S.A.), INC. AND SUBSIDIARIES
SUMMARY OF INVESTMENTS - OTHER
THAN INVESTMENTS IN RELATED PARTIES
AS OF DECEMBER 31, 2009
(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 ............ $ 40,395 $ 41,074 $ 41,074
Corporate obligations ............................. 31,989 32,591 32,591
Public utilities .................................. 2,052 2,095 2,095
Obligations of states and political subdivisions .. 27,222 27,461 27,461
------------ ---------- ---------------
101,658 103,221 103,221
EQUITY SECURITIES AVAILABLE FOR SALE:
Corporate stock ................................... - 42 42
Short-term investments ............................ 380 380 380
------------ ---------- ---------------
Total investments ............................... $ 102,038 $ 103,643 $ 103,643
============ ========== ===============
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)
BALANCE SHEETS
(In thousands except share amounts)
DECEMBER 31,
---------------------
2008 2009
---------- ----------
ASSETS
Property and equipment, net ....................................... $ 935 $ 868
Amounts due from related parties .................................. 11,869 12,697
Other assets ...................................................... 1,678 957
Investment in subsidiaries, net ................................... 64,082 67,530
---------- ----------
Total assets ...................................................... $ 78,564 $ 82,052
========== ==========
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Accrued taxes and other payables ................................ $ 2,009 $ 1,517
Amounts due to subsidiaries ..................................... 3,591 5,763
Debentures ...................................................... 6,979 6,979
Junior subordinated debentures issued to affiliated trusts ...... 20,620 20,620
---------- ----------
Total liabilities ................................................. 33,199 34,879
---------- ----------
Shareholder's equity
Common stock, $1.00 par value, 50,000 shares authorized;
2,484 shares issued and outstanding ........................... 2 2
Paid-in surplus ................................................. 60,584 60,584
Accumulated deficit ............................................. (16,654) (14,472)
Accumulated other comprehensive income:
Unrealized gain on investments held by subsidiary and available
for sale, net of deferred income taxes ........................ 1,433 1,059
---------- ----------
Total shareholder's equity ........................................ 45,365 47,173
---------- ----------
Total liabilities and shareholder's equity ........................ $ 78,564 $ 82,052
========== ==========
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-33
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,
----------------------------------
2007 2008 2009
---------- ---------- ----------
Revenues
Investment income, net .................................. $ 8 $ 1 $ (2)
Interest income, net from related parties ............... 941 647 438
Other income ............................................ 1,020 830 373
---------- ---------- ----------
Total revenues ........................................ 1,969 1,478 809
---------- ---------- ----------
Operating costs and expenses
General and administrative expenses ..................... 3,587 2,949 2,505
Interest expense ........................................ 2,665 2,544 2,336
---------- ---------- ----------
Total operating costs and expenses .................... 6,252 5,493 4,841
---------- ---------- ----------
Loss before income tax benefit ............................ (4,283) (4,015) (4,032)
Federal income tax benefit ................................ 1,430 1,205 897
---------- ---------- ----------
Net loss before equity in net
income of subsidiaries .................................. (2,853) (2,810) (3,135)
Equity in net income of subsidiaries ...................... 2,191 3,335 5,317
---------- ---------- ----------
Net income (loss) ......................................... $ (662) $ 525 $ 2,182
========== ========== ==========
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-34
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,
----------------------------------
2007 2008 2009
---------- ---------- ----------
Operating activities
Net income (loss) ......................................... $ (662) $ 525 $ 2,182
Add (deduct):
Adjustments to reconcile net income (loss) to cash
provided by (applied to) operating activities:
Net income of subsidiaries not distributed to parent ..... (2,191) (3,335) (5,317)
Net (gain) loss on sale of property and equipment ........ (6) 10 33
Amortization and depreciation ............................ 243 265 265
Net change in non-cash balances relating to
operating activities:
Other assets ............................................ 1,059 827 664
Accrued taxes and other payables ........................ 277 (160) (493)
Amounts due to subsidiaries ............................. 1,973 313 2,172
---------- ---------- ----------
Cash provided by (applied to) operating activities ....... 693 (1,555) (494)
---------- ---------- ----------
Investing activities
Cost of property and equipment purchased .................. (420) (267) (200)
Proceeds from sale of property and equipment .............. 49 135 122
---------- ---------- ----------
Cash applied to investing activities ..................... (371) (132) (78)
---------- ---------- ----------
Financing activities
Shareholder dividend from subsidiaries .................... 1,600 2,050 1,400
Payments and loans from related parties ................... 2,164 2,639 2,292
Payments and loans to related parties ..................... (4,086) (3,002) (3,120)
---------- ---------- ----------
Cash provided by (applied to) financing activities ....... (322) 1,687 572
---------- ---------- ----------
Decrease in cash ........................................... - - -
Cash at beginning of year .................................. - - -
---------- ---------- ----------
Cash at end of year ........................................ $ - $ - $ -
========== ========== ===========
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-35
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, 2007
Property and casualty ... $ 1,118 $100,590 $46,389 $ 7,947 $ 66,185 $ 328 $ 41,393 $ 5,852 $ 18,776 $64,432
Agency .................. - - - - - 41 - - 3,412 -
----------- --------- -------- ---------- --------- --------- ---------- ----------- --------- --------
Total ................... $ 1,118 $100,590 $46,389 $ 7,947 $ 66,185 $ 369 $ 41,393 $ 5,852 $ 22,188 $64,432
=========== ========= ======== ========== ========= ========= ========== =========== ========= ========
DECEMBER 31, 2008
Property and casualty ... $ 1,304 $101,459 $43,725 $ 7,820 $ 64,027 $ 3,967 $ 40,940 $ 5,486 $ 18,990 $62,312
Agency .................. - - - - - 27 - - 3,565 -
----------- --------- -------- ---------- --------- --------- ---------- ----------- --------- --------
Total ................... $ 1,304 $101,459 $43,725 $ 7,820 $ 64,027 $ 3,994 $ 40,940 $ 5,486 $ 22,555 $62,312
=========== ========= ======== ========== ========= ========= ========== =========== ========= ========
DECEMBER 31, 2009
Property and casualty ... $ 1,546 $107,341 $44,519 $ 9,094 $ 56,360 $ 3,610 $ 34,214 $ 5,545 $ 16,820 $56,538
Agency .................. - - - - - (4) - - 3,473 -
----------- --------- -------- ---------- --------- --------- ---------- ----------- --------- --------
Total ................... $ 1,546 $107,341 $44,519 $ 9,094 $ 56,360 $ 3,606 $ 34,214 $ 5,545 $ 20,293 $56,538
=========== ========= ======== ========== ========= ========= ========== =========== ========= ========
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-36
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, 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%
============ ============ ============ ============ ============
Year ended December 31, 2009
Property and casualty ...... $ 82,234 $ (34,647) $ 8,951 $ 56,538 15.83%
============ ============ ============ ============ ============
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-37
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:
2007 ........................... $ 170 $ 19 $ (55) $ 134
================ ================ ================ ===============
2008 ........................... $ 134 $ 30 $ (26) $ 138
================ ================ ================ ===============
2009 ........................... $ 138 $ 355 $ (202) $ 291
================ ================ ================ ===============
Allowance for non-collection of reinsurance
recoverables on paid and unpaid losses:
2007 ........................... $ 130 $ 356 $ (247) $ 239
================ ================ ================ ===============
2008 ........................... $ 239 $ 166 $ (174) $ 231
================ ================ ================ ===============
2009 ........................... $ 231 $ 179 $ (112) $ 298
================ ================ ================ ===============
Allowance for non-collection of other assets:
2007 ........................... $ - $ - $ - $ -
================ ================ ================ ===============
2008 ........................... $ - $ 262 $ - $ 262
================ ================ ================ ===============
2009 ........................... $ 262 $ 40 $ - $ 302
================ ================ ================ ===============
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-38
SCHEDULE VI
CHANDLER (U.S.A.), INC. AND SUBSIDIARIES
SUPPLEMENTAL INFORMATION CONCERNING
PROPERTY-CASUALTY INSURANCE OPERATIONS
(In thousands)
DISCOUNT PAID LOSSES AND
DEDUCTED LOSS ADJUSTMENT
FROM RESERVES EXPENSES
--------------- ----------------
Year ended December 31, 2007
Property-casualty ...................... $ - $ 37,608
=============== =================
Year ended December 31, 2008
Property-casualty ...................... $ - $ 37,738
=============== =================
Year ended December 31, 2009
Property-casualty ...................... $ - $ 33,889
=============== =================
SEE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.
PAGE F-39
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.