- -------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------------------
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
---
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2010
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
--- SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from to
--------- ---------
COMMISSION FILE NUMBER: 1-15135
CHANDLER (U.S.A.), INC.
(Exact name of registrant as specified in its charter)
OKLAHOMA 73-1325906
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1010 MANVEL AVENUE, CHANDLER, OKLAHOMA 74834
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (405) 258-0804
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. YES X NO
--- ---
Indicate by check mark whether the registrant has submitted electronically
and posted on its corporate Web site, if any, every Interactive Data File
required to be submitted and posted pursuant to Rule 405 of Regulation S-T
during the preceding 12 months (or for such shorter period that the registrant
was required to submit and post such files). YES NO
--- ---
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, a non-accelerated filer, or a smaller reporting company.
See the definitions of "large accelerated filer," "accelerated filer" and
"smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer Accelerated filer
-- --
Non-accelerated filer X (Do not check if a smaller reporting company)
--
Smaller reporting company
--
Indicate by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act). YES NO X
--- ---
The number of common shares, $1.00 par value, of the registrant outstanding
on July 31, 2010 was 2,484, which are owned by Chandler Insurance Company, Ltd.
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Page i
CHANDLER (U.S.A.), INC.
INDEX
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PART I - FINANCIAL INFORMATION
- ------------------------------
ITEM 1. FINANCIAL STATEMENTS:
- --------------------------------
Consolidated Balance Sheets as of June 30, 2010 (unaudited)
and December 31, 2009 ..................................................1
Consolidated Statements of Operations for the three months
ended June 30, 2010 and 2009 (unaudited) ..............................2
Consolidated Statements of Operations for the six months
ended June 30, 2010 and 2009 (unaudited) ..............................3
Consolidated Statements of Comprehensive Income for the three
months ended June 30, 2010 and 2009 (unaudited) .......................4
Consolidated Statements of Comprehensive Income for the six
months ended June 30, 2010 and 2009 (unaudited) .......................5
Consolidated Statements of Cash Flows for the six months
ended June 30, 2010 and 2009 (unaudited) ..............................6
Notes to Interim Consolidated Financial Statements (unaudited) ..............7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- --------------------------------------------------------------------------
RESULTS OF OPERATIONS ............................................15
---------------------
ITEM 4. CONTROLS AND PROCEDURES .............................................21
- --------------------------------
PART II - OTHER INFORMATION
- ---------------------------
Item 1. Legal Proceedings ...............................................22
Item 1A. Risk Factors ...................................................22
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds ....22
Item 3. Defaults Upon Senior Securities ................................22
Item 4. Reserved .......................................................22
Item 5. Other Information ..............................................22
Item 6. Exhibits .......................................................22
Signatures .................................................................23
PAGE 1
CHANDLER (U.S.A.), INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands except share amounts)
June 30, December 31,
2010 2009
------------ ------------
(Unaudited)
ASSETS
Investments
Fixed maturities available for sale, at fair value
Restricted (amortized cost $31,480 and $34,923 in 2010 and 2009, respectively) ........ $ 32,452 $ 35,392
Unrestricted (amortized cost $67,155 and $66,735 in 2010 and 2009, respectively) ...... 68,310 67,829
Equity securities at fair value (cost $0 in 2010 and 2009) ............................. 42 42
Mortgage loan on real estate, at cost .................................................. 2,334 -
Short-term investments at fair value (amortized cost $0 and $380
in 2010 and 2009, respectively) ....................................................... - 380
------------ ------------
Total investments ..................................................................... 103,138 103,643
Cash and cash equivalents ($1,862 and $2,194 restricted in 2010 and 2009, respectively).. 14,753 7,430
Accrued investment income ............................................................... 981 1,228
Premiums receivable, less allowance for non-collection of $426 and $291 at
2010 and 2009, respectively ............................................................ 21,426 25,305
Reinsurance recoverable on paid losses .................................................. 629 316
Reinsurance recoverable on unpaid losses, less allowance for
non-collection of $266 and $298 at 2010 and 2009, respectively ......................... 38,963 36,588
Reinsurance recoverable on unpaid losses from related parties ........................... 21,383 21,360
Prepaid reinsurance premiums ............................................................ 3,496 3,424
Prepaid reinsurance premiums to related parties ......................................... 12,315 12,276
Deferred policy acquisition costs ....................................................... 2,340 1,546
Property and equipment, net ............................................................. 6,927 7,174
Amounts due from related parties ........................................................ 11,748 12,697
State insurance licenses, net ........................................................... 3,745 3,745
Other assets ............................................................................ 10,725 10,613
------------ ------------
Total assets ............................................................................ $ 252,569 $ 247,345
============ ============
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Unpaid losses and loss adjustment expenses ............................................. $ 109,579 $ 107,341
Unearned premiums ...................................................................... 44,786 44,519
Policyholder deposits .................................................................. 8,400 9,094
Accrued taxes and other payables ....................................................... 9,676 6,831
Premiums payable ....................................................................... 4,161 4,266
Premiums payable to related parties .................................................... 150 522
Senior debentures ...................................................................... 6,979 6,979
Junior subordinated debentures issued to affiliated trusts ............................. 20,620 20,620
------------ ------------
Total liabilities ..................................................................... 204,351 200,172
------------ ------------
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 .................................................................... (13,799) (14,472)
Accumulated other comprehensive income:
Unrealized gain on investments available for sale, net of deferred income taxes ........ 1,431 1,059
------------ ------------
Total shareholder's equity ............................................................ 48,218 47,173
------------ ------------
Total liabilities and shareholder's equity .............................................. $ 252,569 $ 247,345
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 2
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Amounts in thousands)
Three months ended June 30,
--------------------------------
2010 2009
------------- -------------
Premiums and other revenues
Direct premiums written and assumed ........................... $ 21,855 $ 21,034
Reinsurance premiums ceded .................................... (2,207) (2,836)
Reinsurance premiums ceded to related parties ................. (5,853) (5,398)
------------- -------------
Net premiums written and assumed ............................ 13,795 12,800
Decrease in unearned premiums ................................. 91 1,409
------------- -------------
Net premiums earned ......................................... 13,886 14,209
Investment income, net .......................................... 731 780
Interest income, net from related parties ....................... 104 109
Realized investment gains, net .................................. 167 805
Other income .................................................... 436 332
------------- -------------
Total premiums and other revenues ............................. 15,324 16,235
------------- -------------
Operating costs and expenses
Losses and loss adjustment expenses, net of amounts
ceded to related parties of $3,579 and $4,700 in
2010 and 2009, respectively ................................. 8,238 9,500
Policy acquisition costs, net of ceding commissions
received from related parties of $1,719 and $2,052 in
2010 and 2009, respectively ................................. 3,263 2,878
General and administrative expenses ........................... 3,181 2,719
Interest expense .............................................. 578 595
------------- -------------
Total operating costs and expenses .......................... 15,260 15,692
------------- -------------
Income before income taxes ...................................... 64 543
Federal income tax provision .................................... (3) (218)
------------- -------------
Net income .................................................... $ 61 $ 325
============= =============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 3
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Amounts in thousands)
Six months ended June 30,
--------------------------------
2010 2009
------------- -------------
Premiums and other revenues
Direct premiums written and assumed ........................... $ 43,967 $ 45,888
Reinsurance premiums ceded .................................... (4,974) (5,378)
Reinsurance premiums ceded to related parties ................. (11,682) (12,068)
------------- -------------
Net premiums written and assumed ............................ 27,311 28,442
Decrease (increase) in unearned premiums ...................... (157) 636
------------- -------------
Net premiums earned ......................................... 27,154 29,078
Investment income, net .......................................... 1,464 1,541
Interest income, net from related parties ....................... 214 215
Realized investment gains, net .................................. 1,095 1,189
Other income .................................................... 928 775
------------- -------------
Total premiums and other revenues ............................. 30,855 32,798
------------- -------------
Operating costs and expenses
Losses and loss adjustment expenses, net of amounts
ceded to related parties of $6,556 and $8,225 in
2010 and 2009, respectively ................................. 16,481 17,762
Policy acquisition costs, net of ceding commissions
received from related parties of $3,436 and $4,588 in
2010 and 2009, respectively ................................. 6,069 5,794
General and administrative expenses ........................... 6,176 5,824
Interest expense .............................................. 1,155 1,193
------------- -------------
Total operating costs and expenses .......................... 29,881 30,573
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Income before income taxes ...................................... 974 2,225
Federal income tax provision .................................... (301) (829)
------------- -------------
Net income .................................................... $ 673 $ 1,396
============= =============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 4
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Amounts in thousands)
Three months ended June 30,
--------------------------------
2010 2009
------------- ------------
Net income ................................................... $ 61 $ 325
------------- ------------
Other comprehensive income (loss), before income tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period .. 1,186 (158)
Less: Reclassification adjustment for gains included in
net income ............................................. (167) (805)
------------- ------------
Other comprehensive income (loss), before income tax ......... 1,019 (963)
Income tax benefit (provision) related to items of other
comprehensive income (loss) ................................ (347) 327
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Other comprehensive income (loss), net of income tax ......... 672 (636)
------------- ------------
Comprehensive income (loss) .................................. $ 733 $ (311)
============= ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 5
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Amounts in thousands)
Six months ended June 30,
--------------------------------
2010 2009
------------- ------------
Net income .................................................... $ 673 $ 1,396
------------- ------------
Other comprehensive income (loss), before income tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period ... 1,659 (436)
Less: Reclassification adjustment for gains included in
net income .............................................. (1,095) (1,189)
------------- ------------
Other comprehensive income (loss), before income tax .......... 564 (1,625)
Income tax benefit (provision) related to items of other
comprehensive income (loss) ................................. (192) 552
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Other comprehensive income (loss), net of income tax .......... 372 (1,073)
------------- ------------
Comprehensive income .......................................... $ 1,045 $ 323
============= ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 6
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Amounts in thousands)
Six months ended June 30,
------------------------------
2010 2009
------------ ------------
OPERATING ACTIVITIES
Net income .................................................................. $ 673 $ 1,396
Add (deduct):
Adjustments to reconcile net income to cash provided by
operating activities:
Realized investment gains, net .......................................... (1,095) (1,189)
Net (gains) losses on sale of property and equipment .................... (7) 25
Amortization and depreciation ........................................... 775 867
Provision for non-collection of premiums ................................ 135 30
Provision for non-collection of reinsurance recoverables ................ 11 155
Provision for non-collection of debenture ............................... 20 20
Net change in non-cash balances relating to operating activities:
Accrued investment income ............................................. 247 (255)
Premiums receivable ................................................... 3,744 4,155
Reinsurance recoverable on paid losses ................................ (349) (23)
Reinsurance recoverable on unpaid losses .............................. (2,350) (3,534)
Reinsurance recoverable on unpaid losses from related parties ......... (23) (2,244)
Prepaid reinsurance premiums .......................................... (72) (314)
Prepaid reinsurance premiums to related parties ....................... (39) 274
Deferred policy acquisition costs ..................................... (794) (21)
Other assets .......................................................... (353) 178
Unpaid losses and loss adjustment expenses ............................ 2,238 8,712
Unearned premiums ..................................................... 267 (595)
Policyholder deposits ................................................. (694) 2,457
Accrued taxes and other payables ...................................... 864 1,384
Premiums payable ...................................................... (105) (359)
Premiums payable to related parties ................................... (372) (205)
------------ ------------
Cash provided by operating activities ................................... 2,721 10,914
------------ ------------
INVESTING ACTIVITIES
Short-term investments:
Purchases ............................................................... - (380)
Maturities .............................................................. 380 4,900
Unrestricted fixed maturities available for sale:
Purchases ............................................................... (44,978) (53,773)
Sales ................................................................... 36,210 20,629
Maturities .............................................................. 14,500 4,715
Mortgage loan on real estate:
Purchases ............................................................... (2,350) -
Principal payments received ............................................. 16 -
Cost of property and equipment purchased .................................. (133) (131)
Proceeds from sale of property and equipment .............................. 8 19
------------ ------------
Cash provided by (applied to) investing activities ...................... 3,653 (24,021)
------------ ------------
FINANCING ACTIVITIES
Payments and loans from related parties ................................... 2,405 889
Payments and loans to related parties ..................................... (1,456) (1,620)
------------ ------------
Cash provided by (applied to) financing activities ........................ 949 (731)
------------ ------------
Increase (decrease) in cash and cash equivalents during the period .......... 7,323 (13,838)
Cash and cash equivalents at beginning of period ............................ 7,430 20,636
------------ ------------
Cash and cash equivalents at end of period .................................. $ 14,753 $ 6,798
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 7
CHANDLER (U.S.A.), INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED JUNE 30, 2010 AND 2009
(Unaudited)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Chandler
(U.S.A.), Inc. ("Chandler USA") have been prepared in accordance with
generally accepted accounting principles for interim financial information
and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.
They do not include all information and footnotes required by generally
accepted accounting principles for complete financial statements. However,
except as disclosed herein, there have been no material changes in the
information included in Chandler USA's Annual Report on Form 10-K for the
year ended December 31, 2009. In the opinion of management, all adjustments
(consisting of normal recurring adjustments) considered necessary for a fair
presentation have been included. The results of operations for the interim
periods ended June 30, 2010 are not necessarily indicative of the results
that may be expected for the year.
The consolidated financial statements include the accounts of Chandler
USA and all wholly owned subsidiaries that meet consolidation requirements
including National American Insurance Company ("NAICO") and Chandler
Insurance Managers, Inc. ("CIMI").
NOTE 2. SEGMENT INFORMATION
Chandler USA has two reportable operating segments: property and
casualty insurance and agency. The segments are managed separately due to
the differences in the nature of the insurance products and services sold.
The following table presents a summary of Chandler USA's operating segments
for the periods indicated:
PROPERTY
AND
CASUALTY INTERSEGMENT REPORTED
INSURANCE AGENCY ELIMINATIONS BALANCES
------------ ------------ ------------ ------------
(In thousands)
THREE MONTHS ENDED JUNE 30, 2010
Revenues from external customers (1) ........... $ 13,996 $ 326 $ - $ 14,322
Intersegment revenues .......................... 23 382 (405) -
Segment profit (loss) before income taxes (2) .. 302 (238) - 64
THREE MONTHS ENDED JUNE 30, 2009
Revenues from external customers (1) ........... $ 14,319 $ 222 $ - $ 14,541
Intersegment revenues .......................... 42 602 (644) -
Segment profit (loss) before income taxes (2) .. 598 (55) - 543
SIX MONTHS ENDED JUNE 30, 2010
Revenues from external customers (1) ........... $ 27,340 $ 742 $ - $ 28,082
Intersegment revenues .......................... 54 779 (833) -
Segment profit (loss) before income taxes (2) .. 1,312 (338) - 974
Segment assets ................................. 250,894 9,349 (7,674) 252,569
SIX MONTHS ENDED JUNE 30, 2009
Revenues from external customers (1) ........... $ 29,333 $ 520 $ - $ 29,853
Intersegment revenues .......................... 71 1,405 (1,476) -
Segment profit before income taxes (2) ......... 2,042 183 - 2,225
Segment assets ................................. 244,795 8,881 (7,312) 246,364
- ------------------------------------------
<FN>
(1) Consists of net premiums earned and other income.
(2) Includes net realized investment gains.
PAGE 8
Net premiums earned and losses and loss adjustment expenses within the
property and casualty insurance segment can be identified to Chandler USA
designated insurance programs and to each line of insurance. Chandler USA's
chief operating decision makers review net premiums earned and losses and
loss adjustment expenses in assessing the performance of the insurance
programs and lines of business. In addition, Chandler USA's chief operating
decision makers consider many other factors such as the lines of business
offered within an insurance program and the states in which the insurance
programs are offered. Certain discrete financial information is not readily
available by insurance programs or lines of insurance, including assets,
interest income, and investment gains or losses, allocated to each insurance
program or line of insurance. Chandler USA does not consider its insurance
programs or lines of insurance to be reportable segments, however, the
following supplemental information pertaining to each insurance program's
net premiums earned and losses and loss adjustment expenses is presented by
insurance program and line of insurance for the property and casualty
insurance segment.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
2010 2009 2010 2009
------------ ------------ ---------- ------------
(In thousands)
INSURANCE PROGRAM:
- -----------------------------------------
NET PREMIUMS EARNED
Standard lines ........................ $ 13,707 $ 13,434 $ 26,682 $ 27,605
Political subdivisions ................ 161 637 386 1,281
Other ................................. 18 138 86 192
------------ ------------ ---------- ------------
TOTAL ................................. $ 13,886 $ 14,209 $ 27,154 $ 29,078
============ ============ ========== ============
LOSSES AND LOSS ADJUSTMENT EXPENSES
Standard lines ........................ $ 8,216 $ 8,266 $ 16,394 $ 15,969
Political subdivisions ................ (10) 762 (46) 1,170
Other ................................. 32 472 133 623
------------ ------------ ---------- ------------
TOTAL ................................. $ 8,238 $ 9,500 $ 16,481 $ 17,762
============ ============ ========== ============
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
2010 2009 2010 2009
------------ ------------ ---------- ------------
(In thousands)
LINES OF INSURANCE:
- -----------------------------------------
NET PREMIUMS EARNED
Workers compensation .................. $ 5,254 $ 5,152 $ 10,287 $ 10,283
Automobile liability .................. 4,197 4,403 8,289 9,153
Other liability ....................... 2,868 3,258 5,658 6,621
Automobile physical damage ............ 1,207 1,333 2,230 2,936
Inland marine ......................... 188 32 350 35
Property .............................. 156 14 288 16
Other ................................. 16 17 52 34
------------ ------------ ---------- ------------
TOTAL ................................. $ 13,886 $ 14,209 $ 27,154 $ 29,078
============ ============ ========== ============
LOSSES AND LOSS ADJUSTMENT EXPENSES
Workers compensation .................. $ 2,509 $ 6,307 $ 6,267 $ 8,715
Automobile liability .................. 3,955 1,099 6,840 4,873
Other liability ....................... 782 1,472 1,388 2,878
Automobile physical damage ............ 758 714 1,528 1,390
Inland marine ......................... 87 1 175 (63)
Property .............................. 74 (4) 130 (33)
Other ................................. 73 (89) 153 2
------------ ------------ ---------- ------------
TOTAL ................................. $ 8,238 $ 9,500 $ 16,481 $ 17,762
============ ============ ========== ============
PAGE 9
NOTE 3. COMMITMENTS AND CONTINGENCIES
During March 2001, Chandler USA entered into a $3.8 million sale and
leaseback transaction for certain owned equipment for three years. During
March 2004 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 June 30, 2010. The interest rate is subject to a
minimum rate of 5.5%. 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 Chandler Capital Trust I
and Chandler Capital Trust II (the "Capital Trusts") with respect to the trust
preferred securities they have outstanding. The Capital Trusts distribute the
interest received from Chandler USA on the junior subordinated debentures to
the holders of the trust preferred securities to fulfill their obligations
with respect to such securities. The Capital Trusts are wholly owned non-
consolidated subsidiaries of Chandler USA. Chandler USA guarantees payment of
distributions and the redemption price of the trust preferred securities until
the securities are redeemed in full. The total redemption price of the trust
preferred securities is $20.0 million.
NOTE 4. LITIGATION
In October 1999, NAICO provided surety bonds for Gulsby Engineering, Inc.
("Gulsby") in connection with contracts between Gulf Liquids New River
Project, LLC ("Gulf Liquids") and Gulsby for the construction of two gas
processing plants in Louisiana. During 2001, Gulsby became unable to pay
various vendors resulting in payments to vendors by NAICO totaling
$20,182,499. In August 2001, NAICO filed suit in federal court in Louisiana
alleging that Gulf Liquids had breached its obligations under the bonds by
materially altering certain contracts and that, as a result, NAICO was
exonerated on the bonds and should recover the amounts paid to vendors. In
the fall of 2001, Gulsby and Bay Limited, another contractor with whom Gulsby
had entered into a joint venture for the construction of other gas processing
plants for Gulf Liquids, filed lawsuits relating to those plants in Houston,
Texas. Gulf Liquids filed original actions and counterclaims. NAICO intervened
in the Texas lawsuits and, in addition, sued Williams Energy Marketing and
Trading (which later became Williams Power Company, Inc.) ("Williams") alleging
fraud, breach of contract, tortious interference with contractual relations,
conspiracy and alter ego. These claims were asserted against both Gulf Liquids
and Williams. Gulf Liquids asserted counterclaims alleging breach of contract
against NAICO and requesting contractual and statutory damages ranging from $40
million to $80 million. The cases were consolidated for trial in the 215th
Judicial District Court in Harris County, Texas.
The trial in the Harris County cases began in late April 2006, and
concluded August 1, 2006. The jury found in favor of NAICO and Gulsby, Bay
Limited and the joint venture between Gulsby and Bay Limited ("Gulsby-Bay Plant
Partners") on all counts and fixed damages against Gulf Liquids and Williams
totaling $402,568,089. The damages determined by the jury included a total of
$325 million in punitive damages. Among other findings, the jury found:
1. Williams tortiously interfered with NAICO's contractual relationship with
Gulsby and Gulf Liquids; and
2. Williams fraudulently induced NAICO to issue the surety bonds; and
3. Williams defrauded NAICO after the bonds were issued; and
4. Williams' actions were malicious; and
5. Gulf Liquids fraudulently induced NAICO to issue the surety bonds; and
6. Gulf Liquids breached its obligations to NAICO under the bonds; and
7. Williams is responsible for the claims against Gulf Liquids because Gulf
Liquids is the alter ego of Williams; and
8. There were material alterations (cardinal changes) to the contracts NAICO
bonded.
The amounts the jury found owing to NAICO included $20,182,499 in actual
damages, against both Gulf Liquids and Williams, $20 million in punitive
damages against Gulf Liquids, and $50 million in punitive damages against
Williams. The verdicts in favor of Gulsby included $20,941,436 in actual
damages against both Gulf Liquids and Williams, $25 million in punitive
damages against Gulf Liquids and $60 million in punitive damages against
Williams.
NAICO is subrogated to any recovery by Gulsby to the extent of NAICO's
losses on the bonds including loss adjustment expenses with interest from
the date the losses and loss expenses were paid.
PAGE 10
A significant amount of NAICO's losses on the surety bonds were ceded
to various reinsurers and NAICO will be required to reimburse these
reinsurers in accordance with the agreements between NAICO and the reinsurers.
On January 28, 2008, the court entered a final judgment denying Gulf
Liquid's claims against NAICO and Gulsby, denying all of NAICO's claims against
Gulf Liquids and Williams, and entering judgment for Gulsby against Gulf
Liquids for $15,651,927 plus interest at 7.25% compounded annually from January
28, 2008 until paid. The court also ordered Gulf Liquids to pay Gulsby's
taxable court costs, estimated at $100,000. Gulf Liquids has appealed the
judgment entered in favor of Gulsby and the denial of its claims against NAICO
and Gulsby. NAICO has appealed the trial court's denial of its claims against
Gulf Liquids and Williams and seeks entry of judgment upon the jury verdicts
for the amounts the jury found should be awarded to NAICO. Gulsby has also
appealed the trial court's final judgment, contending that judgment should be
entered in its favor against Gulf Liquids and Williams in accordance with the
jury verdicts. The recoverable amounts deducted from Chandler USA's net
liability for losses and loss adjustment expenses related to this litigation
were approximately $10.1 million at June 30, 2010 and December 31, 2009.
NOTE 5. NEW ACCOUNTING STANDARDS
Chandler USA has reviewed the recently issued accounting pronouncements
and concluded that the following new accounting standards and accounting
standard updates are applicable to Chandler USA.
In June 2009, the Financial Accounting Standards Board ("FASB") issued
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. Chandler USA has adopted this new guidance as
of January 1, 2010. 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 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.
Chandler USA has adopted this new guidance as of January 1, 2010. The
adoption of this new guidance did not have any impact on its consolidated
financial statements. While the trusts that hold Chandler USA's junior
subordinated debentures are variable interest entities, and Chandler USA has
100% ownership and has guaranteed the performance of the trusts, Chandler USA
is not the primary beneficiary because its interest is not variable.
Therefore, Chandler USA does not consolidate the trusts under this new
guidance.
In January 2010, the FASB issued new guidance on improving disclosures
about fair value measurements. The new guidance does not change how fair
values are measured. Chandler USA has adopted this new guidance as of January
1, 2010. The adoption of this new guidance did not have any impact on its
consolidated financial statements. The disclosures required by this new
guidance are included in Note 7.
In July 2010, the FASB issued new guidance on disclosures about the credit
quality of financing receivables and the allowance for credit losses. The new
guidance is effective for interim and annual reporting periods ending after
December 15, 2010. The new guidance requires additional disclosures about
financing receivables and the allowances for credit losses. The new guidance
does not change how financing receivables or allowances for credit losses are
measured. Accordingly, except for the additional disclosures, Chandler USA
does not anticipate that the initial application of the new guidance will have
any impact on Chandler USA's consolidated financial statements.
PAGE 11
NOTE 6. INVESTMENTS AND INVESTMENT INCOME
Net investment income and realized investment gains are summarized in the
following table. These amounts are net of investment expenses.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ------------------
2010 2009 2010 2009
-------- -------- -------- --------
(In thousands)
Interest on fixed-maturity investments .................... $ 768 $ 821 $ 1,550 $ 1,594
Interest on short-term investments and cash equivalents ... 10 23 16 76
Interest on mortgage loan on real estate .................. 13 - 13 -
Investment expenses ....................................... (60) (64) (115) (129)
-------- -------- -------- --------
Investment income, net .................................. 731 780 1,464 1,541
Realized gains, net - fixed maturity investments .......... 167 805 1,095 1,189
Realized gains, net - equity securities ................... - - - -
-------- -------- -------- --------
Realized investment gains, net .......................... 167 805 1,095 1,189
-------- -------- -------- --------
$ 898 $ 1,585 $ 2,559 $ 2,730
======== ======== ======== ========
Investment expenses included $21,000 and $39,000 in the second quarter and
first six months of 2010, and $26,000 and $54,000 in the second quarter and
first six months of 2009, respectively, in expense to subsidize a premium
finance program for certain insureds of NAICO with an unaffiliated premium
finance company.
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
JUNE 30, 2010 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 ................................... $ 49,638 $ 940 $ - $ 50,578 $ 50,578
Corporate obligations ............................. 16,120 355 (4) 16,471 16,471
Public utilities .................................. 1,024 45 - 1,069 1,069
Obligations of states and political subdivisions .. 31,853 799 (8) 32,644 32,644
---------- ---------- ---------- ---------- ----------
$ 98,635 $ 2,139 $ (12) $ 100,762 $ 100,762
========== ========== ========== ========== ==========
EQUITY SECURITIES:
Corporate stock ................................... $ - $ 42 $ - $ 42 $ 42
========== ========== ========== ========== ==========
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
========== ========== ========== ========== ==========
PAGE 12
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 fixed
maturity investments that exceeded 10% of shareholder's equity at June 30,
2010 or December 31, 2009.
The fair value of Chandler USA's investments with continuous gross
unrealized losses at June 30, 2010 is presented below:
LESS THAN 12 MONTHS 12 MONTHS OR LONGER TOTAL
----------------------- ----------------------- ------------------------
UNREALIZED UNREALIZED UNREALIZED
FAIR VALUE LOSSES FAIR VALUE LOSSES FAIR VALUE LOSSES
----------- ---------- ----------- ---------- ----------- ----------
(In thousands)
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies .......... $ - $ - $ - $ - $ - $ -
Corporate securities ................. - - 710 - 710 (4)
Public utilities ..................... - - - - - -
Obligations of states and political
subdivisions ....................... 1,030 (8) - - 1,030 (8)
----------- ---------- ----------- ---------- ----------- ----------
$ 1,030 $ (8) $ 710 $ (4) $ 1,740 $ (12)
=========== ========== =========== ========== =========== ==========
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 June 30,
2010.
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 June 30, 2010 are shown below:
AVAILABLE FOR SALE
------------------------
AMORTIZED
COST FAIR VALUE
------------ ----------
(In thousands)
Due in one year or less .......................... $ 6,157 $ 6,179
Due after one year through five years ............ 31,537 32,592
Due after five years through ten years ........... 43,833 44,648
Due after ten years .............................. 17,108 17,343
------------ ----------
$ 98,635 $ 100,762
============ ==========
Realized gains and losses from sales of investments are shown below:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ------------------
2010 2009 2010 2009
-------- -------- -------- --------
(In thousands)
FIXED MATURITIES:
Gross realized gains ........... $ 325 $ 805 $ 1,253 $ 1,189
Gross realized losses .......... (158) - (158) -
-------- -------- -------- --------
Total net realized gains ..... $ 167 $ 805 $ 1,095 $ 1,189
======== ======== ======== ========
PAGE 13
The mortgage loan on real estate is recorded at carrying value, which is
comprised of the original cost net of repayments. The mortgage loan has an
interest rate of prime plus 1%, which was 4.25% at June 30, 2010. The mortgage
loan contract requires monthly payments of both principal and interest. The
mortgage loan contract is due upon demand, and has an amortization period of
10 years.
NAICO is required to deposit cash and securities with regulatory agencies
in which it is licensed as a condition of conducting operations in the state.
In addition, NAICO has deposited cash and securities into a trust account as
collateral for a reinsurance agreement in which NAICO is the assuming
reinsurer. NAICO has also established a letter of credit in the amount of
$500,000 and pledged cash and investments in this amount to secure reserves
assumed under a reinsurance agreement. Certain insurance companies require
CIMI to hold unremitted net insurance premiums in a fiduciary capacity until
disbursed by CIMI. At June 30, 2010, the total amount of cash and securities
restricted as a result of these arrangements was $34.3 million which was a
decrease of $3.3 million from December 31, 2009.
NOTE 7. FAIR VALUE MEASUREMENTS
Fair value is defined as the price that would be received to sell an asset
or paid to transfer a liability in an orderly transaction between market
participants at the measurement date. The quality and reliability of the
information used to determine fair values is prioritized into three broad
categories, with the highest priority given to Level 1 inputs and the lowest
priority to Level 3 inputs. These levels are defined as follows:
Level 1 - Quoted prices (unadjusted) in active markets for identical
assets or liabilities that the reporting entity has the ability to access
at the measurement date.
Level 2 - Observable inputs other than quoted prices included within Level
1 for the asset or liability, either directly or indirectly. If an asset
or liability has a specified term, a Level 2 input must be observable for
substantially the full term of the asset or liability.
Level 3 - Unobservable inputs for the asset or liability.
The following table presents information about Chandler USA's assets
measured at fair value on a recurring basis as of June 30, 2010 and December
31, 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 June 30, 2010 or December 31, 2009.
FAIR VALUE MEASUREMENTS AT JUNE 30, 2010
-------------------------------------------------------------
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 ............ $ - $ 50,578 $ - $ 50,578
Corporate obligations ............................. - 16,471 - 16,471
Public utilities .................................. - 1,069 - 1,069
Obligations of states and political subdivisions .. - 32,644 - 32,644
---------------- --------------- ---------------- -----------
Total fixed maturities available for sale ....... - 100,762 - 100,762
Equity securities - corporate stock ................. - - 42 42
Short-term investments .............................. - - - -
---------------- --------------- ---------------- -----------
Total ............................................. $ - $ 100,762 $ 42 $ 100,804
================ =============== ================ ===========
PAGE 14
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
$382,000 at June 30, 2010 and December 31, 2009, or 0.4% of total Level 2
assets in each period. There were no transfers into or out of Level 1 or Level
2 during the second quarter or six months ended June 30, 2010.
At June 30, 2010, Chandler USA's equity securities which were measured
at fair value using Level 3 inputs consisted of common stock received in
connection with an unaffiliated entity's conversion to a for-profit
corporation. The fair value of this stock was based upon an analytically
determined valuation from an independent rating organization. The following
table presents additional information about assets measured at fair value
using Level 3 inputs for the three and six month periods ended June 30, 2010:
THREE MONTHS SIX MONTHS
FAIR VALUE MEASUREMENTS USING SIGNIFICANT ENDED ENDED
UNOBSERVABLE INPUTS (LEVEL 3) JUNE 30, 2010 JUNE 30, 2010
------------------------------------------------- ------------- -------------
(In thousands)
Equity Securities - corporate stocks:
Beginning balance ............................. $ 42 $ 42
Total realized and unrealized gains (losses):
Included in earnings ...................... - -
Included in other comprehensive income .... - -
Purchases, issuances, sales and settlements:
Purchases ................................. - -
Issuances ................................. - -
Sales ..................................... - -
Settlements ............................... - -
Transfers into Level 3 .................... - -
Transfers out of Level 3 .................. - -
------------- -------------
Ending balance ............................... $ 42 $ 42
============= =============
PAGE 15
NOTE 8. FAIR VALUE DISCLOSURES OF FINANCIAL INSTRUMENTS
Estimated fair value amounts have been determined by Chandler USA using
available market information and appropriate valuation methodologies. However,
considerable judgment is necessarily required in interpreting market data to
develop the estimates of fair value. Accordingly, the estimates of fair values
presented herein are not necessarily indicative of the amounts that Chandler
USA could realize in a current market exchange. The use of different market
assumptions and/or estimation methodologies may have a material effect on the
estimated fair value amounts.
A number of Chandler USA's significant assets (including deferred policy
acquisition costs, property and equipment, reinsurance recoverables, prepaid
reinsurance premiums and state insurance licenses) and liabilities (including
unpaid losses and loss adjustment expenses and unearned premiums) are not
considered financial instruments. Based on the short term nature or other
relevant characteristics, Chandler USA has concluded that the carrying value
of other assets and liabilities considered financial instruments, such as cash
equivalents, mortgage loan on real estate, premiums receivable, policyholder
deposits, accrued taxes and other payables, and premiums payable, approximates
their fair value as of June 30, 2010 and December 31, 2009. The estimated
fair values of Chandler USA's fixed-maturity and equity security investments
are disclosed at Note 6. The fair value of Chandler USA's senior debentures
was estimated to be $7.3 million as of June 30, 2010 and $7.1 million at
December 31, 2009, based on an analytically determined valuation from an
independent rating organization. Chandler USA's senior debentures have not
historically traded regularly, and settlement at the reported fair value may
not be possible. The senior debentures are redeemable by Chandler USA without
penalty or premium and 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 June 30, 2010 was 4.40%. The fair value of Chandler USA's junior
subordinated debentures was estimated to be $23.3 million and $22.0 million
at June 30, 2010 and December 31, 2009, respectively.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
Some of the statements made in this Form 10-Q report, as well as
statements made by Chandler (U.S.A.), Inc. ("Chandler USA") in periodic
press releases and oral statements made by Chandler USA's officials
constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Such forward-looking statements
involve known and unknown risks, uncertainties and other factors that may
cause the actual results, performance or achievements of Chandler USA to be
materially different from any future results, performance or achievements
expressed or implied by the forward-looking statements. Such factors include,
among other things, (i) general economic and business conditions; (ii)
interest rate changes; (iii) competition and regulatory environment in which
Chandler USA and its subsidiaries operate, including the ability to implement
price increases; (iv) claims frequency; (v) claims severity; (vi) catastrophic
events of unanticipated frequency or severity; (vii) the number of new and
renewal policy applications submitted to National American Insurance Company
("NAICO") by its agents; (viii) the ability of NAICO to obtain adequate
reinsurance in amounts and at rates that will not adversely affect its
competitive position; (ix) the ability of NAICO to collect reinsurance
recoverables; (x) the ability of NAICO to maintain favorable insurance
company ratings; and (xi) various other factors including ongoing litigation
matters.
PAGE 16
RESULTS OF OPERATIONS
PREMIUMS EARNED
The following table sets forth premiums earned on a gross basis (before
reductions for premiums ceded to reinsurers) and on a net basis (after such
reductions) for each insurance program as well as each line of insurance for
the periods indicated:
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
--------------------------- ---------------------------
THREE MONTHS ENDED JUNE 30, 2010 2009 2010 2009
---------------------------------- ------------ ------------ ------------ ------------
(In thousands)
INSURANCE PROGRAMS:
Standard lines ................... $ 21,927 $ 21,822 $ 13,707 $ 13,434
Political subdivisions ........... 259 977 161 637
Other ............................ 26 145 18 138
------------ ------------ ------------ ------------
TOTAL ............................ $ 22,212 $ 22,944 $ 13,886 $ 14,209
============ ============ ============ ============
LINES OF INSURANCE:
Workers compensation ............. $ 8,078 $ 8,058 $ 5,254 $ 5,152
Automobile liability ............. 6,057 6,382 4,197 4,403
Other liability .................. 5,694 6,411 2,868 3,258
Automobile physical damage ....... 1,782 1,986 1,207 1,333
Inland marine .................... 296 46 188 32
Property ......................... 282 37 156 14
Other ............................ 23 24 16 17
------------ ------------ ------------ ------------
TOTAL ............................ $ 22,212 $ 22,944 $ 13,886 $ 14,209
============ ============ ============ ============
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
--------------------------- ---------------------------
SIX MONTHS ENDED JUNE 30, 2010 2009 2010 2009
---------------------------------- ------------ ------------ ------------ ------------
(In thousands)
INSURANCE PROGRAMS:
Standard lines ................... $ 43,004 $ 44,314 $ 26,682 $ 27,605
Political subdivisions ........... 612 1,963 386 1,281
Other ............................ 83 206 86 192
------------ ------------ ------------ ------------
TOTAL ............................ $ 43,699 $ 46,483 $ 27,154 $ 29,078
============ ============ ============ ============
LINES OF INSURANCE:
Workers compensation ............. $ 15,889 $ 15,901 $ 10,287 $ 10,283
Automobile liability ............. 12,001 13,281 8,289 9,153
Other liability .................. 11,379 12,811 5,658 6,621
Automobile physical damage ....... 3,309 4,349 2,230 2,936
Inland marine .................... 547 51 350 35
Property ......................... 525 41 288 16
Other ............................ 49 49 52 34
------------ ------------ ------------ ------------
TOTAL ............................ $ 43,699 $ 46,483 $ 27,154 $ 29,078
============ ============ ============ ============
Gross premiums earned decreased $732,000 or 3% and $2.8 million or 6% in
the second quarter and first six months of 2010, respectively, compared to
the 2009 periods. Net premiums earned decreased $323,000 or 2% and $1.9
million or 7% for the second quarter and first six months of 2010,
respectively.
Gross premiums earned in the standard lines program increased $105,000 or
less than 1% and decreased $1.3 million or 3% in the second quarter and first
six months of 2010, respectively, compared to the 2009 periods. Gross
premiums earned from trucking accounts in this program decreased $23,000 and
$1.2 million in the second quarter and first six months of 2010, respectively.
Gross premiums earned in this program for other liability decreased $448,000
and $925,000 in the second quarter and first six months of 2010, respectively,
and gross premiums earned in this program for automobile physical damage
decreased $100,000 and $854,000 in the second quarter and first six months of
2010. Gross premiums earned in this program for automobile liability
increased $33,000 and decreased $596,000 in the second quarter and first six
months of 2010. These decreases were partially offset by increases in
property, inland marine and workers compensation premiums. Net premiums
earned in this program increased $273,000 or 2% and decreased $923,000 or 3%
in the second quarter and first six months of 2010, respectively.
PAGE 17
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
$718,000 or 73% and $1.4 million or 69% in the second quarter and first six
months of 2010, respectively, compared to the 2009 periods. Net premiums
earned in this program decreased $476,000 or 75% and $895,000 or 70% in the
second quarter and first six months of 2010, 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 June 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
the political subdivisions program and reinsures on a quota share basis 35%
of the first $1,000,000 of loss per occurrence of the other liability business
in this program. During July 2010, Greenwich provided notice of termination
of CIMI's underwriting authority for this business effective November 17,
2010. CIMI is currently evaluating other alternatives for placing this
business.
NET INVESTMENT INCOME AND NET REALIZED INVESTMENT GAINS
At June 30, 2010, Chandler USA's investment portfolio consisted primarily
of fixed income U.S. Treasury and government agency bonds, high-quality
corporate and tax exempt bonds, certificates of deposit insured by the FDIC
and a real estate mortgage loan, with approximately 13% invested in cash and
money market instruments. Income generated from this portfolio is largely
dependent upon prevailing levels of interest rates. Chandler USA's portfolio
contains no non-investment grade bonds or real estate investments. Chandler
USA also receives interest income from related parties on intercompany loans.
Net investment income, excluding interest income from related parties
decreased $49,000 or 6% and decreased $77,000 or 5% in the second quarter and
first six months of 2010, respectively. The decreases in 2010 were due
primarily to lower interest rates. Cash and invested assets were $117.9
million at June 30, 2010 compared to $111.1 million at December 31, 2009 and
$112.9 million at June 30, 2009. Net interest income from related parties
decreased $5,000 and $1,000 in the second quarter and first six months of
2010, respectively.
Net realized investment gains were $167,000 and $1.1 million during the
second quarter and first six months of 2010, respectively. The realized
gains resulted from sales of fixed maturities available for sale in the
amount of $36.2 million. Net realized investment gains were $805,000 and
$1.2 million during the second quarter and first six months of 2009.
OTHER INCOME
Other income was $436,000 and $928,000 in the second quarter and first
six months of 2010, respectively, compared to $332,000 and $775,000 in the
second quarter and first six months of 2009. The increases in the 2010
periods were due primarily to an increase in commission income related to
business produced by CIMI for insurance companies other than NAICO. Other
income included net commission income related to business produced by CIMI
for insurance companies other than NAICO totaling $326,000 and $742,000 in
the second quarter and first six months of 2010, respectively, compared to
$222,000 and $520,000 in the second quarter and first six months of 2009.
PAGE 18
LOSSES AND LOSS ADJUSTMENT EXPENSES
Chandler USA estimates losses and loss adjustment expenses based on
historical experience and payment and reporting patterns for the type of
risk involved. These estimates are based on data available at the time of
the estimate and are periodically reviewed by independent professional
actuaries. Although such estimates are management's best estimates of the
expected values, the ultimate liability for unpaid claims may vary from
these values.
The percentage of losses and loss adjustment expenses to net premiums
earned ("loss ratio") was 59.3% and 60.7% for the second quarter and first
six months of 2010, compared to 66.9% and 61.1% in the corresponding 2009
periods. During the second quarter of 2010, NAICO experienced an increase
in losses incurred related to prior accident years totaling $148,000 which
increased the loss ratio by 1.1 percentage points. Loss reserve development
for the first six months of 2010 was redundant by $270,000 which decreased
the loss ratio by 1.0 percentage points. In the second quarter of 2009,
losses and loss adjustment expenses incurred related to prior accident years
were $315,000 and increased the loss ratio by 2.2 percentage points. Loss
reserve development for the first six months of 2009 was redundant by $15,000.
Weather-related losses from wind and hail totaled $193,000 in the second
quarter and first six months of 2010 and increased the respective loss ratios
by 1.4 and 0.7 percentage points. Weather-related losses totaled $62,000 and
$79,000 in the second quarter and first six months of 2009, and increased the
respective 2009 loss ratios by 0.4 and 0.3 percentage points.
POLICY ACQUISITION COSTS
Policy acquisition costs consist of costs associated with the acquisition
of new and renewal business and generally include direct costs such as premium
taxes, commissions to agents and ceding companies and premium-related
assessments and indirect costs such as salaries and expenses of personnel who
perform and support underwriting activities. NAICO also receives ceding
commissions from the reinsurers who assume premiums from NAICO under certain
reinsurance contracts and the ceding commissions are accounted for as a
reduction of policy acquisition costs. Direct policy acquisition costs and
ceding commissions are deferred and amortized over the terms of the policies.
When the sum of anticipated losses, loss adjustment expenses and unamortized
policy acquisition costs exceeds the related unearned premiums, including
anticipated investment income, a provision for the indicated deficiency is
recorded.
The following table sets forth Chandler USA's policy acquisition costs
for each of the periods indicated:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ------------------
2010 2009 2010 2009
-------- -------- -------- --------
(In thousands)
Commissions expense ......................... $ 3,205 $ 2,935 $ 6,452 $ 6,618
Other premium related assessments ........... 303 272 475 539
Premium taxes ............................... 487 479 917 934
Excise taxes ................................ 59 54 117 121
Other expense ............................... 145 121 276 247
-------- -------- -------- --------
Total direct expenses ....................... 4,199 3,861 8,237 8,459
Indirect underwriting expenses .............. 1,470 1,460 2,943 2,890
Commissions received from reinsurers ........ (2,074) (2,511) (4,318) (5,534)
Adjustment for deferred acquisition costs ... (332) 68 (793) (21)
-------- -------- -------- --------
Net policy acquisition costs ................ $ 3,263 $ 2,878 $ 6,069 $ 5,794
======== ======== ======== ========
Total gross direct and indirect expenses as a percentage of direct written
and assumed premiums were 25.9% and 25.4% for the second quarter and first six
months of 2010, compared to 25.3% and 24.7% in the corresponding year ago
periods. Commissions expense as a percentage of gross written and assumed
premiums was 14.7% in the second quarter and the first six months of 2010
compared to 14.0% and 14.4% in the corresponding 2009 periods.
PAGE 19
Indirect underwriting expenses increased $10,000 and $53,000 in the second
quarter and first six months of 2010, respectively, and were 6.7% of total
direct written and assumed premiums in the second quarter and first six months
of 2010, respectively, compared to 6.9% and 6.3% in the corresponding 2009
periods. Indirect expenses include general overhead and administrative costs
associated with the acquisition of new and renewal business, some of which is
relatively fixed in nature, thus, the percentage of such expenses to direct
written and assumed premiums will vary depending on Chandler USA's overall
premium volume. Commissions received from reinsurers as a percent of ceded
reinsurance premiums were 25.7% and 25.9% in the second quarter and first six
months of 2010, respectively, compared to 30.5% and 31.7% in the corresponding
2009 periods. Commissions received from reinsurers decreased $437,000 and
$1.2 million in the second quarter and first six months of 2010 compared to
the corresponding year-ago periods due to a reduction in the ceding commission
rate on premiums ceded to related parties.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses increased $462,000 and $352,000 in
the second quarter and first six months of 2010, respectively, and were 14.0%
and 13.8% of gross premiums earned and other income in the second quarter and
first six months of 2010, respectively, compared to 11.7% and 12.3% for the
corresponding 2009 periods. General and administrative expenses have
historically not varied in direct proportion to Chandler USA's revenues. A
portion of such expenses is allocated to policy acquisition costs (indirect
underwriting expenses) and loss and loss adjustment expenses based on various
factors including employee counts, salaries, occupancy and specific
identification. Because certain types of expenses are fixed in nature, the
percentage of such expenses to revenues will vary depending on Chandler USA's
overall premium volume.
INTEREST EXPENSE
Interest expense decreased $17,000 and $38,000 in the second quarter and
first six months of 2010, respectively, compared to the 2009 periods.
Substantially all of Chandler USA's interest expense is related to its
outstanding senior debentures and junior subordinated debentures. The
decrease in the 2010 periods was due to lower interest rates during 2010, as
a portion of Chandler USA's junior subordinated debentures were issued with
a floating interest rate.
LIQUIDITY AND CAPITAL RESOURCES
In the first six months of 2010, Chandler USA provided $2.7 million in
cash from operations. Unpaid losses and loss adjustment expenses increased
$2.2 million, premiums receivable decreased $3.7 million and accrued taxes
and other payables increased $864,000 during the first six months of 2010.
These were partially offset by an increase in reinsurance recoverable on
unpaid losses of $2.4 million, an increase in deferred policy acquisition
costs of $794,000 and a decrease in policyholder deposits of $694,000. In
the first six months of 2009, Chandler USA provided $10.9 million in cash
from operations. Unpaid losses and loss adjustment expenses increased $8.7
million, premiums receivable decreased $4.2 million and policyholder deposits
increased $2.5 million during the first six months of 2009. These were
partially offset by an increase in reinsurance recoverable on unpaid losses
of $5.8 million.
NAICO is required to deposit cash and securities with regulatory agencies
in which it is licensed as a condition of conducting operations in the state.
In addition, NAICO has deposited cash and securities into a trust account as
collateral for a reinsurance agreement in which NAICO is the assuming
reinsurer. NAICO has also established a letter of credit in the amount of
$500,000 and pledged cash and investments in this amount to secure reserves
assumed under a reinsurance agreement. Certain insurance companies require
CIMI to hold unremitted net insurance premiums in a fiduciary capacity until
disbursed by CIMI. At June 30, 2010, the total amount of cash and securities
restricted as a result of these arrangements was $34.3 million which was a
decrease of $3.3 million from December 31, 2009.
At June 30, 2010, Chandler USA's parent company, Chandler Insurance
Company, Ltd., owed approximately $11.7 million to Chandler USA versus $12.7
million at December 31, 2009 under an Intercompany Credit Agreement (the
"Credit Agreement") covering intercompany loans between the parties. The
Credit Agreement requires interest to be paid at the prime interest rate
published in the Wall Street Journal each month, and balances owed by either
party are payable at any time upon demand.
PAGE 20
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 three years 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 June 30, 2010. The interest rate is subject to a minimum
rate of 5.5%. 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 is a holding company receiving cash principally through
borrowings, subsidiary dividends and other payments, subject to various
regulatory restrictions. The capacity of insurance companies to write
insurance is based on maintaining liquidity and capital resources sufficient
to pay claims and expenses as they become due. The primary sources of
liquidity for Chandler USA's subsidiaries are funds generated from insurance
premiums, investment income, capital contributions from Chandler USA and
proceeds from sales and maturities of portfolio investments. The principal
expenditures are payment of losses and loss adjustment expenses, insurance
operating expenses and commissions.
A significant portion of Chandler USA's consolidated assets represents
assets of NAICO that may not be immediately transferable to Chandler USA in
the form of shareholder dividends, loans, advances or other payments.
Statutes and regulations governing NAICO and other insurance companies
domiciled in Oklahoma regulate the payment of shareholder dividends and other
payments by NAICO to Chandler USA. Under applicable Oklahoma statutes and
regulations, NAICO is permitted to pay shareholder dividends only out of
statutory earned surplus. To the extent NAICO has statutory earned surplus,
NAICO may pay shareholder dividends only to the extent that such dividends
are not defined as extraordinary dividends or distributions. If the
dividends are, under applicable statutes and regulations, extraordinary
dividends or distributions, regulatory approval must be obtained. Under the
applicable Oklahoma statute, and subject to the availability of statutory
earned surplus, the maximum shareholder dividend that may be declared (or
cash or property distribution that may be made) by NAICO in any one calendar
year without regulatory approval is the greater of (i) NAICO's statutory net
income, excluding realized capital gains, for the preceding calendar year;
or (ii) 10% of NAICO's statutory policyholders' surplus as of the preceding
calendar year end, not to exceed NAICO's statutory earned surplus.
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 cash shareholder
dividends of $300,000 to Chandler USA in March 2010 and $1.1 million in June
2010. NAICO paid cash shareholder dividends of $500,000 to Chandler USA in
March 2009 and $900,000 in June 2009.
In addition to the statutory limits described above, the amount of
shareholder dividends and other payments to affiliates can be further limited
by contractual or regulatory restrictions or other agreements with regulatory
authorities restricting dividends and other payments, including regulatory
restrictions that are imposed as a matter of administrative policy. If
insurance regulators determine that payment of a shareholder dividend or other
payments to an affiliate (such as payments under a tax sharing agreement,
payments for employee or other services, or payments pursuant to a surplus
note) would be hazardous to such insurance company's policyholders or
creditors, the regulators may block such payments that would otherwise be
permitted without prior approval.
Historically, NAICO has played a significant role in the servicing of
debt and other obligations of Chandler USA through the payment of shareholder
dividends. These obligations include $7.0 million of 8.75% senior debentures
due in 2014, $13.4 million of 9.75% junior subordinated debentures due in
2033, $7.2 million of floating rate junior subordinated debentures due in
2034 and the obligations under the sale and leaseback transaction discussed
previously. To the extent that the restrictions discussed previously limit
NAICO's ability to pay shareholder dividends or other payments to Chandler
USA, Chandler USA's ability to satisfy the debt obligations may also be
limited.
PAGE 21
LITIGATION
In October 1999, NAICO provided surety bonds for Gulsby Engineering, Inc.
("Gulsby") in connection with contracts between Gulf Liquids New River
Project, LLC ("Gulf Liquids") and Gulsby for the construction of two gas
processing plants in Louisiana. During 2001, Gulsby became unable to pay
various vendors resulting in payments to vendors by NAICO totaling $20,182,499.
In August 2001, NAICO filed suit in federal court in Louisiana alleging that
Gulf Liquids had breached its obligations under the bonds by materially
altering certain contracts and that as a result, NAICO was exonerated on the
bonds and should recover the amounts paid to vendors. In the fall of 2001,
Gulsby and Bay Limited, another contractor with whom Gulsby had entered into a
joint venture for the construction of other gas processing plants for Gulf
Liquids, filed lawsuits relating to those plants in Houston, Texas. Gulf
Liquids filed original actions and counterclaims. NAICO intervened in the
Texas lawsuits and, in addition, sued Williams Energy Marketing and Trading
(which later became Williams Power Company, Inc.) ("Williams") alleging fraud,
breach of contract, tortious interference with contractual relations,
conspiracy and alter ego. These claims were asserted against both Gulf
Liquids and Williams. Gulf Liquids asserted counterclaims alleging breach of
contract against NAICO and requesting contractual and statutory damages
ranging from $40 million to $80 million. The cases were consolidated for
trial in the 215th Judicial District Court in Harris County, Texas. On August
1, 2006, the jury trial concluded in Harris County, Texas, related to the
construction of two gas processing plants in Louisiana. The amounts the jury
found owing to NAICO included approximately $20.2 million in actual damages
and $70.0 million in punitive damages. See Note 4 of Notes to Consolidated
Financial Statements for a discussion of this jury verdict.
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
June 30, 2010 and December 31, 2009.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
As of the end of the period covered by this report and pursuant to Rule
13a-15 of the Securities Exchange Act of 1934 (the "Exchange Act"), Chandler
USA's management, including the Chief Executive Officer and Chief Financial
Officer, conducted an evaluation of the effectiveness and design of Chandler
USA's disclosure controls and procedures (as that term is defined in Rules
13a-15(e) and 15d-15(e) of the Exchange Act). Based upon that evaluation,
Chandler USA's Chief Executive Officer and Chief Financial Officer concluded,
as of the end of the period covered by this report, that Chandler USA's
disclosure controls and procedures were effective in recording, processing,
summarizing and reporting information required to be disclosed by Chandler
USA, within the time periods specified in the Securities and Exchange
Commission's rules and forms.
CHANGES IN INTERNAL CONTROLS
In addition and as of the end of the period covered by this report, there
have been no changes in internal control over financial reporting (as defined
in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) during the quarter to
which this report relates that have materially affected or are reasonably
likely to materially affect, the internal control over financial reporting.
PAGE 22
PART II. OTHER INFORMATION
-----------------
Item 1. LEGAL PROCEEDINGS
-----------------
Chandler USA and its subsidiaries are not parties to any material
litigation other than as is routinely encountered in their
respective business activities. While the outcome of these matters
cannot be predicted with certainty, Chandler USA does not expect
these matters to have a material adverse effect on its financial
condition, results of operations or cash flows. See Note 4 of
Notes to Interim Consolidated Financial Statements for a discussion
of a favorable jury verdict in civil litigation regarding certain
surety bond claims.
Item 1A. RISK FACTORS
------------
There have been no material changes from risk factors previously
disclosed in our Annual Report on Form 10-K for the year ended
December 31, 2009.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
-----------------------------------------------------------
None.
Item 3. DEFAULTS UPON SENIOR SECURITIES
-------------------------------
None.
Item 4. RESERVED
--------
None.
Item 5. OTHER INFORMATION
-----------------
None.
Item 6. EXHIBITS
--------
31.1 Rule 13a-14(a)/15d-14(a) Certifications.
32.1 Section 1350 Certifications.
PAGE 23
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: August 10, 2010 CHANDLER (U.S.A.), INC.
By: /s/ W. Brent LaGere
--------------------------------------
W. Brent LaGere
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
By: /s/ Mark C. Hart
--------------------------------------
Mark C. Hart
Senior Vice President - Finance, Chief
Financial Officer and Treasurer
(Principal Accounting Officer)