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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
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 AMERICAN STOCK EXCHANGE
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. YES X NO
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. X
---
Indicate by check mark whether the registrant is an accelerated filer (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, 2003, 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 29, 2004 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.
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.
Prior to December 2003, Chandler USA was a wholly owned subsidiary of
Chandler Insurance (Barbados), Ltd. ("Chandler Barbados") which, in turn, was a
wholly owned subsidiary of Chandler Insurance. In December 2003, Chandler
Barbados was dissolved following the transfer of its assets, liabilities and
business to Chandler Insurance. Chandler Insurance assumed the obligations of
Chandler Barbados including those under its reinsurance agreements with NAICO
pursuant to a Distribution Agreement and a General Conveyance. The
reorganization of Chandler Barbados and Chandler Insurance was approved by the
Cayman Islands Monetary Authority, the Supervisor of Insurance in Barbados and
the Oklahoma Insurance Department.
NAICO is one of the leading commercial business insurance writers in
Oklahoma, providing property and casualty coverage for businesses in various
industries. NAICO has a network of independent agents, totaling approximately
159 at December 31, 2003, 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++ (Very 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.
In December 2002, Chandler USA completed the sale of its wholly owned
subsidiary, LaGere & Walkingstick Insurance Agency, Inc. ("L&W"), to Brown &
Brown, Inc. L&W previously functioned as Chandler USA's agency segment and is
presented as discontinued operations. See Note 4 to Consolidated Financial
Statements for more information on the sale of L&W.
INSURANCE PROGRAMS
NAICO writes various property and casualty insurance products through
three primary marketing programs. The programs are standard property and
casualty, political subdivisions and surety bonds.
STANDARD PROPERTY AND CASUALTY PROGRAM
NAICO offers workers compensation, automobile liability and physical
damage, other liability (including general liability, products liability and
umbrella liability) and property coverages under its standard property and
casualty program. In marketing these products, NAICO targets companies in the
construction, manufacturing, wholesale, service, oil and gas, and retail
industries. NAICO writes this business principally in Oklahoma and Texas.
PAGE 2
POLITICAL SUBDIVISIONS PROGRAM
Under the political subdivisions program, NAICO writes insurance policies
primarily for school districts in Oklahoma. As of December 31, 2003 NAICO
insured 298 school districts primarily in Oklahoma. The coverages offered
include workers compensation, automobile liability, automobile physical damage,
general liability, property and school board legal liability. NAICO has also
written property and casualty insurance for municipalities, primarily in
Oklahoma. During 2002 and 2003, NAICO significantly reduced its premium
writings in this portion of the program.
SURETY BOND PROGRAM
NAICO writes surety bonds, commonly referred to as contract performance
bonds, to secure the performance of contractors and suppliers on construction
projects. A substantial portion of this business is written in Texas and
Oklahoma. 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 reduced the underwriting authority for the bail
bond portion of the program in 2003, and discontinued the bail bond portion of
the program as of the end of 2003.
The following table shows gross premiums earned and net premiums earned by
insurance program for the years 2001, 2002 and 2003. 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 2001 2002 2003 2001 2002 2003
- ----------------------------------- -------- -------- -------- -------- -------- --------
(In thousands)
Standard property and casualty .... $128,554 $106,051 $ 93,193 $ 53,130 $ 49,570 $ 45,521
Political subdivisions ............ 34,178 35,159 28,926 12,534 13,829 8,093
Surety bonds ...................... 8,796 5,104 3,908 4,125 3,310 2,724
Other (1) ......................... 71 249 252 196 248 245
-------- -------- -------- -------- -------- --------
TOTAL ............................. $171,599 $146,563 $126,279 $ 69,985 $ 66,957 $ 56,583
======== ======== ======== ======== ======== ========
- -------------------------------
(1) This category is comprised primarily of the run-off of discontinued programs and NAICO's
participation in various mandatory workers compensation pools and assigned risks.
LINES OF INSURANCE
The lines of insurance written by NAICO through its programs are workers
compensation, automobile liability, other liability (including general
liability, products liability and umbrella liability), automobile physical
damage, property, surety, inland marine and accident and health. 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,
----------------------------------------------------
1999 2000 2001 2002 2003
-------- -------- -------- -------- --------
Workers compensation ............. 34% 25% 24% 22% 29%
Automobile liability ............. 17% 20% 19% 25% 27%
Other liability .................. 19% 25% 25% 25% 23%
Automobile physical damage ....... 8% 13% 17% 14% 10%
Property ......................... 3% 4% 7% 8% 5%
Surety ........................... 9% 8% 6% 5% 5%
Inland marine .................... 1% 1% 2% 1% 1%
Accident and health .............. 9% 4% -% -% -%
-------- -------- -------- -------- --------
Total .......................... 100% 100% 100% 100% 100%
======== ======== ======== ======== ========
PAGE 3
UNDERWRITING AND CLAIMS
Independent insurance agents submit applications for insurance coverage
for prospective customers to NAICO. NAICO reviews a prospective risk in
accordance with its specific underwriting guidelines. If the risk is approved
and coverage is accepted by the insured, NAICO issues an insurance policy.
NAICO has maintained a continuous contractual relationship with an
underwriting manager for the bail bond portion of the surety bond program.
During 2001, 2002 and 2003, the gross and net premiums earned for bail bonds
were $2.3 million, $2.3 million and $1.2 million, respectively. This
underwriting manager is an independent contractor and is responsible for
collection of all premiums and payment of all commissions to bail bond agents.
Additionally, it is responsible for all claims and recoveries and is required
to maintain collateral security for each bond. NAICO reduced the underwriting
authority for this underwriting manager in 2003, and discontinued the bail bond
portion of the surety bond program at the end of 2003.
NAICO's claims department reviews and administers all claims. 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 claim 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.
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 or
proportional 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. A majority of
NAICO's reinsurance programs renew on January 1 or July 1 of each year. NAICO
renewed all January 1, 2004 reinsurance programs. At the present time, NAICO
expects to renew the reinsurance programs that renew on July 1, 2004.
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.
Under the 2001 workers compensation reinsurance program, NAICO's net
retention was 34% of the first $10,000 of loss per occurrence plus 30% of
$90,000 excess of $10,000 of loss per occurrence. Effective July 1, 2001,
NAICO added 28% of the $100,000 excess of $100,000 of loss per occurrence layer
to its net retention. Effective January 1, 2002, NAICO's net retention
increased to 50% of the first $200,000 of loss per occurrence. Effective
July 1, 2002, NAICO's net retention increased to 50% of the first $250,000 of
loss per occurrence. Effective January 1, 2003, NAICO's net retention
increased to 70% of the first $250,000 of loss per occurrence, and effective
July 1, 2003, NAICO's net retention increased to 70% of the first $500,000 of
loss per occurrence.
Under the 2001 casualty reinsurance program, NAICO retained 64% of the
first $100,000 of loss per occurrence. Effective July 1, 2001, NAICO added
60% of $150,000 excess of $100,000 of loss per occurrence plus 40% of $250,000
excess of $250,000 of loss per occurrence to its net retention. Effective
January 1, 2002, NAICO's net retention increased to 80% of the first $250,000
of loss per occurrence plus 40% of $250,000 excess of $250,000 of loss per
occurrence. Effective July 1, 2002, NAICO's net retention decreased to 80% of
the first $250,000 of loss per occurrence. Effective January 1, 2003, NAICO's
net retention decreased to 70% of the first $250,000 of loss for occurrence,
and effective July 1, 2003, NAICO's net retention increased to 70% of the first
$500,000 of loss per occurrence.
PAGE 4
Under the 2001 construction surety bond reinsurance program, NAICO's net
retention was 50% of the first $350,000 plus 5% of $6,000,000 excess of
$4,000,000 per principal (e.g., contractor). Effective April 1, 2002, NAICO's
net retention increased to 50% of the first $1,000,000 plus 10% of $4,000,000
excess of $1,000,000 per principal. Effective January 1, 2003, NAICO increased
its retention for the first $1,000,000 of loss per principal from 50% to 70%.
NAICO elected not to renew its construction surety bond excess of loss
reinsurance effective April 1, 2003 due to the decreased premium volume in
this program and to the current market for this reinsurance. Effective April
1, 2003, NAICO retains 70% of the losses in this program.
Under the 2001 and 2002 property reinsurance program, NAICO retained 33%
of the first $1,500,000 of risk for each loss per risk or location. Effective
January 1, 2003, NAICO retains 23.1% of the first $1,500,000 of risk for each
loss per risk or location. Effective January 1, 2004, NAICO retains 23.1% of
the first $3,000,000 of risk for each loss per risk or location. Under the
2001 and 2002 automobile physical damage reinsurance program, NAICO retained
the first $500,000 of each loss per occurrence, plus 5% of amounts exceeding
$500,000 of each loss per occurrence up to $1 million of each loss per
occurrence. Effective January 1, 2003, NAICO retains 70% of the first $500,000
of each loss per occurrence, plus 3.5% of amounts exceeding $500,000 of each
loss per occurrence up to $1 million of each loss per occurrence. Effective
January 1, 2004, NAICO retains 70% of each loss per occurrence on automobile
physical damage risks. NAICO purchases catastrophe protection for its
automobile physical damage and certain property 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 both
automobile physical damage and property losses to $1,000,000 for 2001 and 2002,
$700,000 for 2003 and $1,400,000 effective January 1, 2004 for each loss
occurrence.
On November 26, 2002, President Bush signed the Terrorism Risk Insurance
Act of 2002 (the "Act"), establishing a program for commercial property and
casualty losses, including workers compensation, resulting from foreign acts of
terrorism. The Act requires commercial insurers to offer terrorism coverage on
its commercial property and casualty lines of business. Each insurance company
will be responsible for a deductible based on a percentage of direct earned
premiums from the previous calendar year, which rises from 7% for losses
occurring in 2003 to 10% in 2004 and 15% in 2005. The Federal Government will
pay 90% of covered terrorism losses that exceed company deductibles. The
Federal Government will be required to recoup the portion of any federal
compensation paid to the extent that industry retentions are less than $10
billion for events in 2003, $12.5 billion for 2004 and $15 billion for 2005.
The recoupment will be accomplished through a surcharge on all policyholders,
not to exceed 3% of premiums in a given year. The Act is scheduled to expire
on December 31, 2005.
Effective January 1, 2003, NAICO purchased quota share reinsurance for its
deductible under the Act limiting NAICO's retention to 10% of such deductible
subject to a reinsurance limit of $9,450,000 for each loss occurrence. The
reinsurance coverage is also limited to $9,450,000 for all occurrences for any
year. NAICO also purchased excess of loss reinsurance covering acts of
terrorism that provides coverage of $20 million excess of $10 million of loss
per occurrence based on NAICO's net retention.
PAGE 5
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, 2003.
CEDED REINSURANCE
NET PREMIUMS FOR A.M. BEST
REINSURANCE THE YEAR ENDED COMPANY
NAME OF REINSURER RECOVERABLE (1) DECEMBER 31, 2003 RATING
- -------------------------------------------- --------------- ----------------- ------------
(Dollars in thousands)
Swiss Reinsurance America Corporation ...... $ 28,649 $ 130 A+
Chandler Insurance ......................... 19,529 25,992 -(2)
Employers Reinsurance Corporation .......... 18,385 18,907 A
Red River Reinsurance, Ltd. ................ 5,904 5,016 -(3)
GE Reinsurance Corporation ................. 5,109 (113) A
--------------- -----------------
Top five reinsurers ...................... $ 77,576 $ 49,932
=============== =================
All reinsurers ........................... $ 92,522 $ 66,604
=============== =================
Percentage of total represented by top
five reinsurers .......................... 84% 75%
- --------------------------------------------
(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, 2003.
(2) Chandler Insurance owns 100% of the common stock of Chandler USA, which in turn owns
100% of the common stock of NAICO. 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, 2003, Chandler Insurance had cash and investments with a fair
value of $19.7 million deposited in a trust account for the benefit of NAICO. Chandler
Insurance includes amounts assumed from Chandler Barbados that resulted from the transfer
of its business to Chandler Insurance in December 2003.
(3) Red River Reinsurance, Ltd. ("Red River") is required to secure its reinsurance obligations
by depositing acceptable securities in trust for NAICO's benefit. At December 31, 2003,
Red River's reinsurance recoverables were collateralized by cash and investments with a
fair value of $6.2 million deposited in a trust account for the benefit of NAICO and by
premiums payable to Red River of approximately $730,000.
Transamerica Occidental Life Insurance Company ("Transamerica") reinsured
NAICO for certain workers compensation risks during 1989, 1990 and 1991.
Beginning in 1996, Transamerica refused to pay NAICO for balances that it owed
under the reinsurance treaties. Transamerica owes NAICO approximately $1.6
million for reinsurance recoverables on paid losses and loss adjustment
expenses as of December 31, 2003. NAICO is currently engaged in arbitration
in order to enforce the terms of the reinsurance treaties.
Reliance Insurance Company ("Reliance") reinsured NAICO for certain
workers compensation risks during 1998. At December 31, 2003, NAICO had
reinsurance recoverables from Reliance for paid and unpaid losses of
approximately $3.1 million. During October 2001, the Commonwealth of
Pennsylvania placed Reliance in liquidation. At this time, NAICO is unable
to determine the amount of its reinsurance recoverables from Reliance that will
ultimately be collected and has fully reserved the carrying value of such
amounts as of December 31, 2003.
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 $454,000, $1.7 million and $604,000 during 2001, 2002 and 2003,
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 to net premiums written and assumed ("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,
--------------------------------------------
1999 2000 2001 2002 2003
-------- -------- -------- -------- --------
(Dollars in thousands)
Workers compensation:
Net premiums earned ............................ $ 29,244 $ 21,161 $ 16,449 $ 14,808 $ 16,378
Loss ratio ..................................... 77% 70% 105% 99% 72%
Automobile liability:
Net premiums earned ............................ $ 15,027 $ 17,517 $ 13,386 $ 16,526 $ 15,624
Loss ratio ..................................... 78% 78% 70% 81% 49%
Other liability:
Net premiums earned ............................ $ 15,785 $ 20,992 $ 17,470 $ 16,458 $ 12,870
Loss ratio ..................................... 70% 56% 57% 80% 94%
Automobile physical damage:
Net premiums earned ............................ $ 7,039 $ 11,434 $ 12,174 $ 9,552 $ 5,508
Loss ratio ..................................... 104% 85% 52% 35% 36%
Property:
Net premiums earned ............................ $ 2,972 $ 3,377 $ 4,806 $ 5,543 $ 3,072
Loss ratio ..................................... 203% 179% 93% 50% 74%
Surety:
Net premiums earned ............................ $ 8,061 $ 6,760 $ 4,125 $ 3,310 $ 2,723
Loss ratio ..................................... 6% 33% 57% 59% 34%
Inland marine:
Net premiums earned ............................ $ 775 $ 1,088 $ 1,256 $ 760 $ 408
Loss ratio ..................................... 138% 142% 143% 100% 54%
Accident and health:
Net premiums earned ............................ $ 8,195 $ 3,190 $ 319 $ - $ -
Loss ratio ..................................... 104% 161% 281% -% -%
Total:
Net premiums earned ............................ $ 87,098 $ 85,519 $ 69,985 $ 66,957 $ 56,583
Loss ratio ..................................... 79% 76% 75% 76% 66%
Underwriting expense ratio (1) ................. 32% 30% 33% 34% 47%
-------- -------- -------- -------- --------
Combined ratio (1) ............................. 111% 106% 108% 110% 113%
======== ======== ======== ======== ========
- ---------------------------------------------------
(1) Interest expense and certain litigation expenses are not considered underwriting expenses;
therefore, such costs have been excluded from these ratios. The underwriting expense ratio
for 2003 was impacted by a 23% decrease in net premiums written and assumed during 2003.
Certain types of expenses are fixed in nature, resulting in an increased ratio for this
period. See also "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS."
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 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. 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 $5.6 million and $5.7 million at December 31, 2002 and 2003,
respectively. 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.
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. In addition, NAICO receives direct assignments
to write workers compensation for such insureds in lieu of participating in
the pools. The consolidated financial statements reflect the reserves for
unpaid losses and loss adjustment expenses and net premiums earned from its
participation in the pools and from these direct assignments.
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,
-------------------------------------------------
1999 2000 2001 2002 2003
--------- --------- --------- --------- ---------
(In thousands)
Net balance at beginning of year ............. $ 39,921 $ 51,378 $ 46,707 $ 32,812 $ 33,191
--------- --------- --------- --------- ---------
Net losses and loss adjustment expenses incurred
related to:
Current year ............................. 65,139 60,020 39,881 34,928 26,108
Prior years .............................. 3,520 4,979 12,669 15,784 11,092
--------- --------- --------- --------- ---------
Total .................................. 68,659 64,999 52,550 50,712 37,200
--------- --------- --------- --------- ---------
Net paid losses and loss adjustment expenses
related to:
Current year ............................. (33,306) (33,661) (22,646) (13,283) (10,626)
Prior years .............................. (23,896) (36,009) (43,799) (37,050) (30,422)
--------- --------- --------- --------- ---------
Total .................................. (57,202) (69,670) (66,445) (50,333) (41,048)
--------- --------- --------- --------- ---------
Net balance at end of year ................... $ 51,378 $ 46,707 $ 32,812 $ 33,191 $ 29,343
========= ========= ========= ========= =========
During 2001, NAICO experienced incurred losses related to prior accident
years totaling $12.7 million due primarily to increased loss severity in the
standard property and casualty and political subdivisions programs. A
substantial part of this loss development was for workers compensation losses
in the 1999 accident year. NAICO's net retention for workers compensation
losses increased substantially in 1999 due to the rescission of certain
reinsurance treaties covering this line of business. Also contributing to the
adverse loss development were provisions for potentially uncollectible
reinsurance and deductibles of approximately $1.2 million during 2001, an
increase in losses in the surety bond program and approximately $878,000 in
losses for the runoff of a discontinued group accident and health program.
During 2002, NAICO experienced incurred losses related to prior accident
years totaling $15.8 million primarily in the standard property and casualty
program including both liability lines and workers compensation. This adverse
development is generally the result of ongoing analysis of recent loss
development trends that reflect an increase in loss severity within the
1997-2000 accident years. The adverse loss development included approximately
$2.0 million for provisions for potentially uncollectible reinsurance and
deductibles.
During 2003, NAICO experienced incurred losses related to prior accident
years totaling $11.1 million primarily in the standard property and casualty
program. This adverse development was due primarily to an increase in losses
in the workers compensation and other liability lines of business in the
1998-2001 accident years. A reduction in losses for the 2002 accident year
partially offset this adverse development. The adverse loss development
included approximately $1.3 million for provisions for potentially
uncollectible reinsurance and deductibles.
The following table represents the development of net balance sheet
reserves for 1994 through 2003. 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.
PAGE 9
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 1997 for claims
that occurred in 1994 will be included in the cumulative deficiency amount for
years 1994, 1995, 1996 and 1997. This table does not present accident or
policy year development data. Conditions and trends that have affected
development of the liability in the past may not necessarily occur in the
future. Accordingly, it may not be appropriate to extrapolate future
deficiencies or redundancies based on this table.
DEVELOPMENT OF RESERVES
AS OF DECEMBER 31,
-----------------------------------------------------------------------------------------------------
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
--------- --------- --------- --------- --------- --------- ---------- ---------- --------- ---------
(In thousands)
Net reserve for unpaid
losses and loss adjustment
expenses .................... $ 64,308 $ 58,340 $ 53,845 $ 54,035 $ 39,921 $ 51,378 $ 46,707 $ 32,812 $ 33,191 $ 29,343
Net paid (cumulative) as of
One year later ............. 30,771 31,768 28,572 30,330 23,896 36,009 43,799 37,050 30,422
Two years later ............ 45,321 44,471 40,857 42,934 34,966 58,979 66,141 60,560
Three years later .......... 51,985 49,262 45,668 49,735 45,390 72,052 81,635
Four years later ........... 54,825 51,101 47,995 56,306 51,364 80,860
Five years later ........... 55,691 52,126 50,700 58,843 55,445
Six years later ............ 56,278 54,040 51,878 60,821
Seven years later .......... 57,826 54,574 52,964
Eight years later .......... 58,378 55,294
Nine years later ........... 59,143
Net liability re-estimated as of
One year later ............. 62,757 59,644 55,713 55,772 43,441 56,357 59,376 48,596 44,283
Two years later ............ 61,924 59,605 55,599 56,362 45,373 67,469 74,325 67,903
Three years later .......... 62,737 59,155 54,528 58,176 50,146 77,842 86,377
Four years later ........... 62,636 58,247 54,834 61,096 55,303 83,860
Five years later ........... 62,195 58,445 55,615 62,750 58,060
Six years later ............ 62,295 58,567 56,347 63,629
Seven years later .......... 62,630 59,013 56,879
Eight years later .......... 63,026 59,296
Nine years later ........... 63,302
Net cumulative (deficiency)
redundancy ................. $ 1,006 $ (956) $ (3,034) $ (9,594) $(18,139) $(32,482) $ (39,670) $ (35,091) $(11,092) $ -
Supplemental gross data:
Gross liability ............ $143,437 $116,149 $ 78,114 $ 73,721 $ 80,701 $ 98,460 $ 100,173 $ 84,756 $ 92,606 $ 87,768
Reinsurance recoverable .... 79,129 57,809 24,269 19,686 40,780 47,082 53,466 51,944 59,415 58,425
--------- --------- --------- --------- --------- --------- ---------- ---------- --------- ---------
Net liability-end of year... $ 64,308 $ 58,340 $ 53,845 $ 54,035 $ 39,921 $ 51,378 $ 46,707 $ 32,812 $ 33,191 $ 29,343
========= ========= ========= ========= ========= ========= ========== ========== ========= =========
Gross re-estimated
liability - latest ....... $143,266 $120,526 $ 94,132 $ 96,398 $122,620 $169,673 $ 216,197 $ 222,553 $156,078
Re-estimated recoverable -
latest ................... 79,964 61,230 37,253 32,769 64,560 85,813 129,820 154,650 111,795
--------- --------- --------- --------- --------- --------- ---------- ---------- ---------
Net re-estimated
liability - latest........ $ 63,302 $ 59,296 $ 56,879 $ 63,629 $ 58,060 $ 83,860 $ 86,377 $ 67,903 $ 44,283
========= ========= ========= ========= ========= ========= ========== ========== =========
Gross cumulative (deficiency)
redundancy ................. $ 171 $ (4,377) $(16,018) $(22,677) $(41,919) $(71,213) $(116,024) $(137,797) $(63,472)
========= ========= ========= ========= ========= ========= ========== ========== =========
PAGE 10
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.
Fixed-maturity 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 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.
Securities not classified as held to maturity or trading 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 investment securities below their carrying value that are other
than temporary are recognized in earnings.
As of December 31, 2003, all of the investments of NAICO were in
fixed-maturity investments (rated Aa3 or AA or better by Moody's Investors
Service, Inc. or Standard & Poor's, respectively), 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. 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. During 2003, Chandler USA purchased and
cancelled $16.7 million principal amount of the Debentures, and at December 31,
2003, there was $7,254,000 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 addition 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"). Trust I is a Delaware statutory business trust and is a wholly owned
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. Distributions on the Trust I
Preferred Securities are payable quarterly at a fixed annual rate of 9.75%
beginning August 23, 2003. 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 11
Trust I used the proceeds from the sale of the Trust I Preferred
Securities to purchase 9.75% junior subordinated debentures (the "Junior
Debentures I") of Chandler USA in like amount, and will distribute any cash
payments it receives thereon to the holders of its preferred and common
securities. The Junior Debentures I are the sole assets of Trust I.
Distributions on the Junior Debentures I are payable quarterly at a fixed
annual rate of 9.75% beginning August 23, 2003. 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.
In December 2003, Chandler USA established Chandler Capital Trust II
("Trust II"). Trust II is a Delaware statutory business trust and is a wholly
owned consolidated subsidiary of Chandler USA. On December 16, 2003, Trust II
issued $7.0 million of capital securities ("Trust II Preferred Securities") to
InCapS Funding II, Ltd., an unaffiliated company established under the laws of
the Cayman Islands, in a private transaction. Distributions on the Trust II
Preferred Securities are payable quarterly at a floating rate of 4.10% over
LIBOR (LIBOR is recalculated quarterly and the interest rate may not exceed
12.5% prior to January 8, 2009) beginning April 8, 2004. The interest rate for
the initial quarterly period was determined to be 5.26813%. 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 II used the proceeds from the sale of the Trust II Preferred
Securities to purchase floating rate junior subordinated debentures (the
"Junior Debentures II") of Chandler USA in like amount, and will distribute
any cash payments it receives thereon to the holders of its preferred and
common securities. The Junior Debentures II are the sole assets of Trust II.
Distributions on the Junior Debentures II are payable quarterly at a floating
rate of 4.10% over LIBOR (LIBOR is recalculated quarterly and the interest rate
may not exceed 12.5% prior to January 8, 2009) beginning April 8, 2004. The
interest rate for the initial quarterly period was determined to be 5.26813%.
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 sale of the Trust I Preferred Securities and the Trust II Preferred
Securities issued by Trust I and Trust II resulted in net proceeds of $19.3
million to Chandler USA, net of placement costs. Issuance costs in the amount
of $711,000 have been capitalized and will be amortized over the stated
maturity periods of thirty years. Chandler USA used $13.3 million of the
proceeds to purchase $16.7 million principal amount of its outstanding
Debentures. The Debentures purchased by Chandler USA were cancelled. The
purchase and cancellation of the Debentures resulted in a pre-tax gain of $3.1
million, net of an adjustment to unamortized issuance costs, which is included
in other income in the consolidated statement of operations. Chandler USA also
contributed $5.0 million of the proceeds to NAICO to be used for general
corporate purposes. The Junior Debentures I and Junior Debentures II and
related interest expense are eliminated in Chandler USA's consolidated
financial statements.
EMPLOYEES AND ADMINISTRATION
At December 31, 2003, Chandler USA and its subsidiaries had approximately
279 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 much
of the last decade, the industry has generally had excess underwriting capacity
resulting in depressed premium rates and expanded policy terms, which generally
occur when excess underwriting capacity exists. NAICO has been able to
increase its pricing for most coverages during 2002 and 2003, which has
generally been the trend industry wide. However, 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 12
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.
PAGE 13
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.
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, 2003, NAICO had statutory earned surplus of $12.5
million. Applying the Oklahoma statutory limits described above, the maximum
shareholder dividend NAICO may pay in 2004 without the approval of the Oklahoma
Department of Insurance is $5.0 million. NAICO paid shareholder dividends
totaling $7.0 million and $3.5 million to Chandler USA in 2001 and 2002,
respectively. The Oklahoma Department of Insurance approved the payment of the
extraordinary dividend by NAICO to Chandler USA in 2001.
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
- ----------------------------------
(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.
PAGE 14
(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).
The ratios of total adjusted capital to authorized control level RBC for NAICO
were 5.8:1 and 6.7:1 at December 31, 2002 and 2003, 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 12
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
five 2003 ratios that were outside of the "usual values," four of which
resulted primarily from adverse loss development as explained below.
NAICO's "two-year overall operating ratio" for 2003 was 103% compared to a
usual value of less than 100%. Factors that contributed to NAICO's ratio
include a lower ratio of investment income to net premiums earned due primarily
to lower interest rates experienced during 2003, and to adverse loss
development recorded during 2002 and 2003 for accident years prior to 2002.
Excluding this loss development, the two-year overall operating ratio would
have been 75% for 2003.
NAICO's "investment yield" as calculated using the IRIS formula was 2.8%
during 2003 compared to a usual value of greater than 4.5% and less than 10.0%.
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), and NAICO holds only a small investment in
equity securities. 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.
Moreover, in periods of relatively low interest rates, NAICO generally shortens
maturities and accepts lower yields to reduce market risk for future rate
increases.
NAICO's "one-year reserve development to policyholders' surplus" and
"two-year reserve development to policyholders' surplus" for 2003 were 22% and
67%, respectively, compared to usual values of less than 20% for each ratio.
The primary reason for these unusual values was adverse loss development
experienced during 2002 and 2003 related to the 1997 - 2001 accident years.
This adverse loss development relates primarily to the workers compensation and
other liability lines of business in NAICO's standard property and casualty and
political subdivisions programs. Also contributing to the adverse loss
development were provisions for potentially uncollectible reinsurance
recoverables and deductibles of $1.9 million and $1.3 million during 2002 and
2003, respectively. Statutory accounting requires that these write-downs of
receivables and recoverables be reflected as prior year loss development.
NAICO's "estimated current reserve deficiency to policyholders' surplus"
was 31% at December 31, 2003 compared to a usual value of less than 25%. The
adverse loss development experienced in 2002 and 2003 related to prior accident
years was primarily responsible for this ratio being outside of the normal
range. NAICO experienced significant growth from 1996 through 2000, with gross
premiums written increasing from $108 million in 1996 to $197 million in 2000.
During 2001, 2002 and 2003, NAICO implemented substantial price increases on
most lines of business. NAICO also exited some classes of business and
non-renewed accounts with unfavorable frequency and/or severity
characteristics. These actions resulted in a reduction in gross premiums
written from $197 million in 2000 to $118 million in 2003. Management
believes that while the insured exposure base has been significantly reduced,
the premium for that exposure has increased significantly. The calculation of
this ratio assumes that factors that led to past under reserving will cause
current under reserving without regard to changes in premium volume, premium
rates, product mix, the amount of risk retained by NAICO and current reserving
practices.
PAGE 15
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 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.
NAICO also leases approximately 1,500 square feet for a branch office in
Richardson, Texas. Chandler USA believes such space is sufficient for its
operations for the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
Chandler Insurance and certain of its subsidiaries and affiliates,
including Chandler USA, are involved in litigation with their director and
officer liability insurer. See Note 11 to Consolidated Financial Statements
for a discussion of this and other litigation matters.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the quarter
ended December 31, 2003.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
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 as
of December 31, 2000, and the related consolidated statement of operations,
comprehensive income, shareholder's equity and cash flows for the years ended
December 31, 2000 were audited by Deloitte & Touche LLP, independent auditors,
whose independent auditors' report expressed an unqualified opinion and
included an explanatory paragraph relating to litigation. The consolidated
balance sheets of Chandler USA and its subsidiaries as of December 31, 2001,
2002 and 2003 and the related consolidated statements of operations,
comprehensive income, shareholder's equity and cash flows for the years ended
December 31, 2001, 2002 and 2003 have been audited by Tullius Taylor Sartain &
Sartain LLP, independent auditors, whose independent auditors' report expresses
an unqualified opinion. 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). All periods have
been restated to reflect the results of L&W as a discontinued operation.
PAGE 16
ITEM 6. SELECTED FINANCIAL DATA (CONTINUED)
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1999 2000 2001 2002 2003
---------- ---------- ---------- ---------- ----------
OPERATING DATA (1) (Dollars in thousands)
Revenues
Direct premiums written and assumed ............. $ 169,569 $ 197,196 $ 158,964 $ 140,162 $ 118,444
========== ========== ========== ========== ==========
Net premiums earned ............................. $ 87,098 $ 85,519 $ 69,985 $ 66,957 $ 56,583
Interest income, net ............................ 3,927 4,281 3,632 2,540 2,148
Interest income, net from related parties ....... - - 371 380 412
Realized investment gains, net .................. 57 144 2,654 794 2,351
Fee for rescinded reinsurance treaties .......... 10,000 - - - -
Other income (2) ................................ 164 301 101 261 5,077
---------- ---------- ---------- ---------- ----------
Total revenues .................................... 101,246 90,245 76,743 70,932 66,571
---------- ---------- ---------- ---------- ----------
Operating expenses
Losses and loss adjustment expenses ............. 68,659 64,999 52,550 50,712 37,200
Policy acquisition costs ........................ 21,195 16,882 10,869 10,239 11,278
General and administrative expenses ............. 9,126 10,557 11,549 12,473 13,486
Interest expense ................................ 1,494 2,255 2,240 2,234 2,441
---------- ---------- ---------- ---------- ----------
Total operating expenses .......................... 100,474 94,693 77,208 75,658 64,405
---------- ---------- ---------- ---------- ----------
Income (loss) from continuing operations before
income taxes .................................... 772 (4,448) (465) (4,726) 2,166
Federal income tax benefit (provision) ............ (326) 1,347 (16) 1,680 (192)
---------- ---------- ---------- ---------- ----------
Income (loss) from continuing operations .......... 446 (3,101) (481) (3,046) 1,974
Income (loss) from discontinued operations ........ (533) (894) (622) 284 -
Gain on sale of subsidiary ........................ - - - 671 -
---------- ---------- ---------- ---------- ----------
Net income (loss) ................................. $ (87) $ (3,995) $ (1,103) $ (2,091) $ 1,974
========== ========== ========== ========== ==========
Combined loss and underwriting expense ratio (3) .. 111% 106% 108% 110% 113%
BALANCE SHEET DATA
Cash and investments .............................. $ 93,666 $ 104,760 $ 73,378 $ 68,276 $ 69,198
Amounts due from related parties .................. - - 7,880 10,582 9,642
Total assets ...................................... 256,836 273,498 234,809 229,855 217,593
Unpaid losses and loss adjustment expenses ........ 98,460 100,173 84,756 92,606 87,768
Amounts due to related parties .................... 533 717 - - -
Debentures ........................................ 24,000 24,000 24,000 24,000 7,254
Trust preferred securities ........................ - - - - 20,000
Total liabilities ................................. 210,097 228,647 191,067 186,855 173,754
Shareholder's equity .............................. 46,739 44,851 43,742 43,000 43,839
- ---------------------------------------------------
(1) All periods have been restated to reflect the results of L&W as a discontinued operation. See Note
4 to Consolidated Financial Statements for more information.
(2) Other income for 2003 included a $3.1 million gain on the purchase and cancellation of $16.7 million
principal amount of Debentures, and $1.7 million for the amortization of the deferred gain on a sale
and leaseback transaction. For additional information, see "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS."
(3) Interest expense is not considered an underwriting expense and has been excluded from this ratio.
PAGE 17
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 three separate
marketing programs: standard property and casualty, political subdivisions
and surety bonds (including both construction bonds and bail bonds). 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. 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 maintains certain wholesale operations related to NAICO's school districts
and trucking insurance.
SUMMARY OF RESULTS
Net income was $2.0 million for the year ended December 31, 2003, compared
to a net loss of $2.1 million for 2002 and $1.1 million for 2001. Income from
continuing operations was $2.0 million for 2003 compared to a loss from
continuing operations of $3.0 million and $481,000 during 2002 and 2001,
respectively. Net income for 2003 included $3.1 million in gains on the
purchase and cancellation of $16.7 million principal amount of Debentures, and
$1.7 million for the amortization of the deferred gain on a sale and leaseback
transaction. These transactions are discussed in more detail under "Other
Income" and "Liquidity and Capital Resources."
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.
DISCONTINUED OPERATIONS
In December 2002, Chandler USA completed the sale of its wholly owned
subsidiary L&W to Brown & Brown, Inc. for $3,247,000 in cash and a $361,000
note receivable that was paid in December 2003. Chandler USA recorded an
after-tax gain of $671,000 on the sale in 2002 based on the minimum purchase
price for the transaction, after deducting Chandler USA's goodwill related to
L&W of $2,350,000, equity in L&W of $224,000 and approximately $400,000 of
expenses in connection with the sale. The gain on the sale may be increased
over the next three years depending on certain adjustments to the purchase
price as defined in the terms of the transaction, with a maximum purchase price
of $6.0 million.
L&W continues to be a significant producer of business for NAICO. Retail
business produced by L&W and placed with NAICO constituted approximately 9% of
NAICO's direct premiums written and assumed in 2003. Chandler USA maintains
certain wholesale operations related to NAICO's school districts and trucking
insurance through CIMI, an underwriting manager that was established in
December 2002. L&W previously functioned as Chandler USA's agency segment and
is presented as discontinued operations.
Chandler USA agreed to indemnify Brown & Brown, Inc. for any breach of a
representation, warranty or covenant made in connection with the sale for a
period of three years, and has deposited cash in the amount of $500,000 into a
trust account for the benefit of Brown & Brown, Inc. as security. Prior to
completing the sale, L&W transferred its real estate to NAICO, and transferred
substantially all of its remaining assets and liabilities, primarily premiums
receivable and premiums payable, to Chandler USA through a shareholder
dividend. Following the completion of the sale, L&W changed its name to Brown
& Brown of Central Oklahoma, Inc.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with 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.
PAGE 18
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 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. See Notes to Consolidated Financial Statements.
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 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. 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.
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.
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.
PAGE 19
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 $103 million,
or 87%, of NAICO's direct written premiums in 2003 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 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.
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. NAICO's underwriting philosophy is to forego underwriting risks
from which it is unable to obtain what it believes to be adequate premium 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.
A 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 much of the last
decade, the industry has generally had excess underwriting capacity resulting
in depressed premium rates and expanded policy terms, which generally occur
when excess underwriting capacity exists. NAICO has been able to increase its
pricing for most coverages during 2002 and 2003, which has generally been the
trend industry wide. However, 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.
PAGE 20
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."
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 repricing, 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 the financial
year (losses incurred and recognized by Chandler USA regardless of the year in
which the claim occurred) and accident year (losses incurred by Chandler USA
for a particular year regardless of the period in which Chandler USA recognizes
the costs) loss ratios (computed by dividing losses and loss adjustment
expenses by net premiums earned) in each of the years presented. 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,
----------------------------------
2001 2002 2003
---------- ---------- ----------
(Dollars in thousands)
INSURANCE PROGRAMS
- ----------------------------------------
STANDARD PROPERTY AND CASUALTY
Net premiums earned .................. $ 53,130 $ 49,570 $ 45,521
Financial year loss ratio ............ 71.0% 81.1% 65.1%
Accident year loss ratio ............. 65.3% 43.7% 48.1%
POLITICAL SUBDIVISIONS
Net premiums earned .................. $ 12,534 $ 13,829 $ 8,093
Financial year loss ratio ............ 91.1% 55.9% 70.7%
Accident year loss ratio ............. 73.8% 29.8% 43.0%
SURETY BONDS
Net premiums earned .................. $ 4,125 $ 3,310 $ 2,724
Financial year loss ratio ............ 56.7% 59.4% 33.5%
Accident year loss ratio ............. 91.9% 21.7% 20.4%
OTHER (1)
Net premiums earned .................. $ 196 $ 248 $ 245
Financial year loss ratio ............ 555.4% 332.7% 374.0%
Accident year loss ratio ............. 108.4% 77.6% 71.1%
TOTAL
Net premiums earned .................. $ 69,985 $ 66,957 $ 56,583
Financial year loss ratio ............ 75.1% 75.7% 65.7%
Accident year loss ratio ............. 68.5% 39.9% 46.1%
- --------------------------------
(1) This category is comprised primarily of the run-off of discontinued programs
and NAICO's participation in various mandatory workers compensation pools and
assigned risks.
PAGE 21
YEAR ENDED DECEMBER 31,
----------------------------------
2001 2002 2003
---------- ---------- ----------
(Dollars in thousands)
LINES OF INSURANCE
- ---------------------------------------
WORKERS COMPENSATION
Net premiums earned ................. $ 16,449 $ 14,808 $ 16,378
Financial year loss ratio ........... 105.4% 99.4% 71.8%
Accident year loss ratio ............ 77.1% 44.9% 46.3%
AUTOMOBILE LIABILITY
Net premiums earned ................. $ 13,386 $ 16,526 $ 15,624
Financial year loss ratio ........... 70.0% 81.2% 49.4%
Accident year loss ratio ............ 70.0% 46.3% 49.8%
OTHER LIABILITY
Net premiums earned ................. $ 17,470 $ 16,458 $ 12,870
Financial year loss ratio ........... 57.4% 80.2% 94.0%
Accident year loss ratio ............ 56.9% 37.0% 50.9%
AUTOMOBILE PHYSICAL DAMAGE
Net premiums earned ................. $ 12,174 $ 9,552 $ 5,508
Financial year loss ratio ........... 52.0% 35.3% 36.0%
Accident year loss ratio ............ 48.7% 35.6% 32.7%
PROPERTY
Net premiums earned ................. $ 4,806 $ 5,543 $ 3,072
Financial year loss ratio ........... 92.8% 49.9% 73.7%
Accident year loss ratio ............ 97.7% 33.6% 55.9%
SURETY
Net premiums earned ................. $ 4,125 $ 3,310 $ 2,723
Financial year loss ratio ........... 56.7% 59.4% 33.5%
Accident year loss ratio ............ 91.9% 21.8% 20.4%
INLAND MARINE
Net premiums earned ................. $ 1,256 $ 760 $ 408
Financial year loss ratio ........... 143.0% 99.7% 54.1%
Accident year loss ratio ............ 124.8% 45.4% 30.9%
ACCIDENT AND HEALTH
Net premiums earned ................. $ 319 $ - $ -
Financial year loss ratio ........... 281.2% -% -%
Accident year loss ratio ............ -% -% -%
TOTAL
Net premiums earned ................. $ 69,985 $ 66,957 $ 56,583
Financial year loss ratio ........... 75.1% 75.7% 65.7%
Accident year loss ratio ............ 68.5% 39.9% 46.1%
PAGE 22
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 2001 2002 2003 2001 2002 2003
- ----------------------------------------- -------- -------- -------- -------- -------- --------
(In thousands)
Standard property and casualty .......... $128,554 $106,051 $ 93,193 $ 53,130 $ 49,570 $ 45,521
Political subdivisions .................. 34,178 35,159 28,926 12,534 13,829 8,093
Surety bonds ............................ 8,796 5,104 3,908 4,125 3,310 2,724
Other ................................... 71 249 252 196 248 245
-------- -------- -------- -------- -------- --------
TOTAL ................................... $171,599 $146,563 $126,279 $ 69,985 $ 66,957 $ 56,583
======== ======== ======== ======== ======== ========
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
-------------------------- --------------------------
LINES OF INSURANCE 2001 2002 2003 2001 2002 2003
- ----------------------------------------- -------- -------- -------- -------- -------- --------
(In thousands)
Workers compensation .................... $ 57,585 $ 41,958 $ 29,821 $ 16,449 $ 14,808 $ 16,378
Automobile liability .................... 27,237 27,143 27,538 13,386 16,526 15,624
Other liability ......................... 36,166 36,078 34,715 17,470 16,458 12,870
Automobile physical damage .............. 13,516 10,745 9,146 12,174 9,552 5,508
Property ................................ 22,377 22,722 19,359 4,806 5,543 3,072
Surety .................................. 8,796 5,104 3,908 4,125 3,310 2,723
Inland marine ........................... 5,580 2,813 1,792 1,256 760 408
Accident and health ..................... 342 - - 319 - -
-------- -------- -------- -------- -------- --------
TOTAL ................................... $171,599 $146,563 $126,279 $ 69,985 $ 66,957 $ 56,583
======== ======== ======== ======== ======== ========
Gross premiums earned decreased 15% and 14% in 2002 and 2003,
respectively, as NAICO continued to focus on improving underwriting
profitability in its core programs through stricter underwriting policies,
a reduction in the number of appointed agents and by discontinuing certain
accounts where rates were not believed to be adequate. Gross premiums earned
in Texas decreased 23% and 18% in 2002 and 2003, respectively, and gross
premiums earned in Oklahoma decreased 5% and 15% in 2002 and 2003. The workers
compensation line of business accounted for a significant portion of the
decreases. Net premiums earned decreased 4% and 15% in 2002 and 2003,
respectively. During 2001 and 2002, NAICO had quota share reinsurance in
effect that reduced NAICO's net retention for its casualty and workers
compensation lines of business and reduced its net premiums earned by $11.3
million and $4.6 million, respectively. NAICO elected not to renew this
reinsurance upon expiration.
Gross premiums earned in the standard property and casualty program
decreased 18% and 12% in 2002 and 2003, respectively. The decreases were due
primarily to discontinuing certain accounts where rates were not believed to be
adequate. Increases in premium rates partially offset the decrease in premium
production. Gross premiums earned in Texas decreased $13.7 million and $9.9
million in 2002 and 2003, respectively, and gross premiums earned in Oklahoma
decreased $7.2 million and $6.0 million in 2002 and 2003, respectively. Net
premiums earned decreased 7% and 8% in 2002 and 2003, respectively. The quota
share reinsurance reduced net premiums earned by $9.5 million and $3.8 million
in this program in 2001 and 2002, respectively.
Gross premiums earned in the political subdivisions program increased 3%
in 2002 and decreased 18% in 2003. Gross premiums earned in the school
districts portion of the program increased $4.5 million in 2002 and decreased
$3.9 million in 2003. Gross premiums earned for the municipalities portion of
the program decreased $3.5 million and $2.3 million in 2002 and 2003,
respectively, as NAICO discontinued writing most of these accounts. Net
premiums earned increased 10% in 2002 and decreased 41% in 2003. The quota
share reinsurance reduced net premiums earned by $1.8 million and $835,000 in
this program in 2001 and 2002, respectively. The decrease in 2003 was due to
the decrease in gross premiums earned, and to Chandler Insurance assuming a
portion of the risk for the property and automobile physical damage coverages.
PAGE 23
Gross premiums earned in the surety bond program decreased 42% and 23% in
2002 and 2003, respectively. The decreases are primarily due to stricter
underwriting policies and a reduction in the number of appointed agents that
produce this business as NAICO focuses on improving underwriting profitability
in this program. Net premiums earned in the surety bond program decreased 20%
and 18% in 2002 and 2003, respectively. NAICO elected not to renew its
construction surety bond excess of loss reinsurance effective April 1, 2003 due
to the decreased premium volume in this program and to the current market for
this reinsurance.
Other programs in the preceding table include premiums from the runoff of
various programs which are no longer offered by NAICO, 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, and direct assignments to write workers compensation for such insureds
in certain states in lieu of participating in related pools.
NET INTEREST INCOME AND NET REALIZED INVESTMENT GAINS
At December 31, 2003, Chandler USA's investment portfolio consisted
primarily of fixed income U.S. Government and high-quality corporate bonds,
with approximately 10% 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 interest income from continuing operations, excluding interest income
from related parties, decreased 30% and 15% in 2002 and 2003, respectively.
The decreases were due primarily to lower interest rates. Interest income from
related parties was $380,000 and $412,000 during 2002 and 2003, respectively.
See Liquidity and Capital Resources.
Net realized investment gains were $2,654,000, $794,000 and $2,351,000 in
2001, 2002 and 2003, respectively. The net realized investment gains in 2001
and 2002 resulted primarily from sales of fixed maturity investments available
for sale to provide cash for operating activities due to the decrease in
written premiums. Realized investment gains in 2003 included a gain of $1.7
million from the sale of 19,371 shares of common stock of Insurance Services
Office, Inc. ("ISO") that was recorded during the second quarter of 2003.
NAICO received these shares in 1997 as a result of ISO converting to a
for-profit corporation.
The average net yield on the portfolio, including net realized investment
gains, was 7.7%, 4.8% and 6.7% in 2001, 2002 and 2003, respectively. The
average net yield on the portfolio, excluding net realized investment gains,
was 4.4%, 3.7% and 3.2% for 2001, 2002 and 2003, respectively. 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, 2003 was approximately $11 million. The
average yield on the portfolio before deducting investment expenses was 5.9%,
4.4% and 3.6% in 2001, 2002 and 2003, respectively, excluding capital gains.
OTHER INCOME
During 2003, Chandler USA's other income included a $3.1 million gain on
the purchase and cancellation of $16.7 million of its Debentures. In addition,
the amortization of a deferred gain related to a sale and leaseback transaction
increased other income by $1.7 million. The deferred gain is being amortized
into income over the final year of the lease following the exercise of the
option for Chandler USA to repurchase the equipment at the end of the lease.
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."
PAGE 24
The percentage of losses and loss adjustment expenses to net premiums
earned ("loss ratio") was 75.1%, 75.7% and 65.7% in 2001, 2002 and 2003,
respectively. Weather-related losses (net of applicable reinsurance) from
wind and hail were $2.0 million, $1.5 million and $1.9 million in 2001, 2002
and 2003, respectively, and increased the respective loss ratios by 2.9, 2.2
and 3.4 percentage points.
During 2001, NAICO experienced incurred losses related to prior accident
years totaling $12.7 million due primarily to increased loss severity in the
standard property and casualty and political subdivisions programs. A
substantial part of this loss development was for workers compensation losses
in the 1999 accident year. NAICO's net retention for workers compensation
losses increased substantially in 1999 due to the rescission of certain
reinsurance treaties covering this line of business. Also contributing to the
adverse loss development were provisions for potentially uncollectible
reinsurance and deductibles of approximately $1.2 million during 2001, an
increase in losses in the surety bond program and approximately $878,000 in
losses for the runoff of a discontinued group accident and health program.
During 2002, NAICO experienced incurred losses related to prior accident
years totaling $15.8 million primarily in the standard property and casualty
program including both liability lines and workers compensation. This adverse
development is generally the result of ongoing analysis of recent loss
development trends that reflect an increase in loss severity within the
1997-2000 accident years. The adverse loss development included approximately
$2.0 million for provisions for potentially uncollectible reinsurance and
deductibles.
During 2003, NAICO experienced incurred losses related to prior accident
years totaling $11.1 million primarily in the standard property and casualty
program. This adverse development was due primarily to an increase in losses
in the workers compensation and other liability lines of business in the
1998-2001 accident years. A reduction in losses for the 2002 accident year
partially offset this adverse development. The adverse loss development
included approximately $1.3 million for provisions for potentially
uncollectible reinsurance and deductibles.
Reliance reinsured NAICO for certain workers compensation risks during
1998. At December 31, 2003, NAICO had reinsurance recoverables from Reliance
for paid and unpaid losses of approximately $3.1 million. During October 2001,
the Commonwealth of Pennsylvania placed Reliance in liquidation. At this time,
NAICO is unable to determine the amount of its reinsurance recoverables from
Reliance that will ultimately be collected and has fully reserved the carrying
value of such amounts as of December 31, 2003. 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 2001, 2002 and 2003, NAICO incurred
charges of $454,000, $1.7 million and $604,000, respectively, in adjustments
to ceded losses and loss adjustment expenses for amounts deemed uncollectible.
NAICO did not receive any claims related to the September 11, 2001
terrorist attacks on the World Trade Center and does not believe that it has
any significant exposure to these and related losses. While several of NAICO's
reinsurers did experience significant losses related to these attacks, it
currently does not appear that these losses will impair the reinsurers' ability
to pay claims.
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.
PAGE 25
The following table sets forth Chandler USA's policy acquisition costs
from continuing operations for each of the three years ended December 31, 2001,
2002 and 2003:
YEAR ENDED DECEMBER 31,
--------------------------------
2001 2002 2003
---------- ---------- ----------
(In thousands)
Commissions expense ........................ $ 23,241 $ 20,151 $ 17,644
Other premium related assessments .......... 463 1,397 1,159
Premium taxes .............................. 4,276 2,764 2,446
Excise taxes ............................... 234 240 260
Dividends to policyholders ................. 143 105 (52)
Other expense .............................. 295 567 598
---------- ---------- ----------
Total direct expenses ...................... 28,652 25,224 22,055
Indirect underwriting expenses ............. 9,099 8,135 7,675
Commissions received from reinsurers ....... (27,325) (22,309) (18,643)
Adjustment for deferred acquisition costs .. 443 (811) 191
---------- ---------- ----------
Net policy acquisition costs ............... $ 10,869 $ 10,239 $ 11,278
========== ========== ==========
Total gross direct and indirect expenses as a percentage of direct written
and assumed premiums were 23.7%, 23.8% and 25.1% in 2001, 2002 and 2003,
respectively. For these periods, commission expense as a percentage of gross
written and assumed premiums was 14.6%, 14.4% and 14.9%. The increase in
commission expense was primarily due to an increase in contingent commissions
to agents that resulted from lower loss ratios than had been projected for
these agents. Premium taxes decreased $1.5 million in 2002 due to the decrease
in written premiums, a decrease in expenses associated with guaranty fund
assessments and the elimination of a 2% tax on workers compensation premiums
written in Oklahoma. However, an increase in premium related assessments in
Oklahoma offset part of this savings. Expenses associated with guaranty fund
assessments, net of applicable premium tax credits, were approximately
$489,000, $31,000 and $32,000 in 2001, 2002 and 2003, 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 of
such assessments.
Indirect underwriting expenses were 5.7%, 5.8% and 6.5% of total direct
written and assumed premiums in 2001, 2002 and 2003, respectively. 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 29.2%, 30.8% and 28.0% in 2001, 2002 and 2003, respectively.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses from continuing operations were 6.7%,
8.5% and 10.7% of gross premiums earned in 2001, 2002 and 2003, respectively.
General and administrative expenses for 2002 included $297,000 for settlement
of certain litigation, and $736,000 for a reserve for receivables related to
certain derivative claims. An increase in employee related expenses and fees
paid to state insurance departments contributed to the increase in expense in
2003. 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 less than 1% in 2002 and increased 9% in 2003.
The increase in 2003 resulted from the increased total debt including Chandler
USA's Debentures and trust preferred securities. See "Liquidity and Capital
Resources."
PAGE 26
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.
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. As of December 31, 2003, all of NAICO's
fixed-maturity investments were rated Aa3 or AA or better by Moody's Investors
Service, Inc. or Standard & Poor's, respectively.
NAICO purchases fixed-maturity 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. 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. Securities not classified as held to maturity or trading 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 used $27.8 million, $7.5 million and $6.0 million in cash
from operations during 2001, 2002 and 2003, respectively. During this time,
written premiums decreased from $197.2 million in 2000 to $159.0 million in
2001, $140.2 million in 2002 and $118.4 million in 2003. The decreases in
written premiums were due to NAICO's re-underwriting its book of business, and
discontinuing certain accounts and classes of business where premium rates were
not believed to be adequate. Cash flow from operations is negatively impacted
during times when premiums decline since claim payments for any given year will
include payments for claims on insurance policies written in prior years. The
cash used by operations was largely funded from sales and maturities of
investments and certain financing activities described below.
Cash flows from investing activities during 2003 were primarily the result
of normal purchases and sales of investment securities. Net realized
investment gains before income taxes were $2,654,000, $794,000 and $2,351,000
during 2001, 2002 and 2003, respectively, from the sale of investments. NAICO
received proceeds of $73.1 million, $31.5 million and $24.5 million during
2001, 2002 and 2003, respectively, from the sale of available for sale
securities prior to their maturity. The proceeds and related net realized
investment gains in 2001, 2002 and 2003 provided cash for operating activities
due to the decrease in written premiums. During 2003, the market value of
NAICO's available for sale fixed-income investments decreased by $500,000 due
primarily to changes in interest rates experienced during this time. The
average maturity of NAICO's investments was 3.1 years and 5.0 years at December
31, 2002 and 2003, respectively. Cash flows from investing activities also
included $3.8 million from a sale and leaseback transaction for certain
equipment owned by Chandler USA during 2001. During 2003, Chandler USA
exercised its option to repurchase the equipment at the end of the lease for
approximately $3.0 million. The deferred gain is being amortized into income
over the final year of the lease, resulting in other income of $1.7 million in
2003. See Note 12 to Consolidated Financial Statements. Cash flows from
investing activities also included proceeds from the sale of L&W in 2002 of
$3.1 million net of cash disposed of as part of the sale. See Note 4 to
Consolidated Financial Statements for more information.
Cash flows from financing activities during 2003 included $19.3 million
in proceeds from the issuance of trust preferred securities, net of related
issuance costs, less $12.8 million for payments to purchase $16.7 million
principal amount of Chandler USA's Debentures. See Note 6 to Consolidated
Financial Statements.
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. Chandler USA has deposited cash into a trust account as security
related to certain indemnification provisions related to its sale of L&W. At
December 31, 2003, the total amount of cash and investments restricted as a
result of these arrangements was $8.3 million.
PAGE 27
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,
2002 and 2003, Chandler USA had a receivable of $10.6 million and $9.6
million, respectively, under the Credit Agreement, and Chandler USA earned
$371,000, $380,000 and $412,000 in interest income under the Credit Agreement
during 2001, 2002 and 2003, respectively.
LITIGATION
Certain officers and directors of Chandler USA and Chandler Insurance
were named as defendants in certain litigation involving CenTra, Inc
("CenTra"). This litigation was concluded in 2002. In accordance with its
Articles of Association, Chandler Insurance and its subsidiaries have advanced
the litigation expenses of these persons in exchange for undertakings to repay
such expenses if those persons are later determined to have breached the
standard of conduct provided in the Articles of Association. These expenses
together with certain other expenses may be recovered from Chandler Insurance's
director and officer liability insurance policy (the "D&O Insurer"). As a
result of various events in 1995, 1996 and 1997, Chandler Barbados and Chandler
USA recorded estimated recoveries of costs from its D&O Insurer totaling
$3,456,000 and $1,044,000, respectively, for reimbursable amounts previously
paid that relate to allowable defense and litigation costs for such parties.
Chandler Barbados and Chandler USA received payment for a 1995 claim during
1996 in the amount of $636,000 and $159,000, respectively. The balance of
$2,820,000 and $885,000 is included in other assets in Chandler Insurance's and
Chandler USA's respective balance sheets. Chandler Insurance assumed this
receivable from Chandler Barbados during December 2003 under the reorganization
of these companies. Chandler Insurance and its subsidiaries contend they are
entitled to a total of $5 million under the applicable insurance policy to the
extent they have advanced reimbursable expenses. The D&O Insurer contends that
certain policy provisions exclude coverage for these claims. On August 22,
2001, Chandler Insurance and its subsidiaries, including Chandler USA, filed an
action in the State District Court in Oklahoma City, Oklahoma ("Oklahoma State
Court") alleging that the director and officer liability insurance policies
should be rescinded and seeking repayment of more than $5 million in premiums
they previously paid. Chandler Insurance and its subsidiaries are currently
involved in litigation with the insurer for payment of the policy balance or
rescission and repayment of premiums previously paid. The litigation is
pending in the Oklahoma State Court. The case is still in the early pleading
stages and Chandler USA cannot predict the date of resolution or the outcome
of this case. Chandler Insurance and its subsidiaries may or may not recover
the remaining policy limits or the previously paid premiums and could incur
significant costs in resolving this matter.
Transamerica reinsured NAICO for certain workers compensation risks during
1989, 1990 and 1991. Beginning in 1996, Transamerica refused to pay NAICO for
balances that it owed under the reinsurance treaties. Transamerica owes NAICO
approximately $1.6 million for reinsurance recoverables on paid losses and loss
adjustment expenses as of December 31, 2003. NAICO is currently engaged in
arbitration in order to enforce the terms of the reinsurance treaties.
Chandler USA and its subsidiaries are not parties to any other 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.
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, 2003, substantially all of the investments of NAICO
were in fixed-maturity investments (rated Aa3 or AA or better by Moody's
Investors Service, Inc. or Standard & Poor's, respectively), interest-bearing
money market accounts and collateralized repurchase agreements. NAICO does
not hold any investments classified as trading account assets or derivative
financial instruments.
PAGE 28
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 hypothetical
Fair value at change in change in
December 31, interest rate interest rate
---------------------- (bp=basis points) ----------------------
2002 2003 2002 2003
---------- ---------- ----------------- ---------- ----------
(Dollars in thousands) (Dollars in thousands)
Fixed-maturity investments .... $ 58,327 $ 61,980 100 bp increase.. $ 56,630 $ 59,226
200 bp increase.. 55,022 56,663
100 bp decrease.. 60,126 64,946
200 bp decrease.. 62,034 68,146
The table above illustrates, for example, that an instantaneous 200 basis
point increase in market interest rates at December 31, 2003 would reduce the
estimated fair value of NAICO's fixed-maturity investments by approximately
$5.3 million at that date.
Chandler USA is obligated for $7.3 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, 2003, the fair value of Chandler USA's
Debentures was estimated to be $5.9 million based on recent purchases of the
Debentures by Chandler USA. 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 $13.0 million principal
amount of trust preferred securities that mature in 2033 with a fixed interest
rate of 9.75%, and $7.0 million principal amount of trust preferred securities
that mature in 2034 with a floating rate of 4.10% over LIBOR, currently
5.26813%. At December 31, 2003, the fair value of Chandler USA's trust
preferred securities was estimated to be $20.0 million.
During March 2001, Chandler USA entered into a $3.8 million sale and
leaseback transaction for certain owned equipment. Chandler USA agreed to
lease the equipment for three years with monthly rental installments equal to
the sum of (i) $22,167 plus (ii) interest on the unpaid lease balance at a
floating interest rate of 1% over Chase Manhattan Bank Prime, which was 4.0%
at December 31, 2003. The sale and leaseback transaction resulted in a
deferred gain of $2.0 million which is included in accrued taxes and other
payables. Chandler USA has exercised its option to repurchase the equipment
at the end of the lease for approximately $3.0 million. The deferred gain is
being amortized into income over the final year of the lease, resulting in
other income of $1.7 million in 2003.
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.
PAGE 29
ITEM 9A. 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
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.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
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 58 Chairman of the Board, Chief Executive Officer, Compensation
Committee Member and Director.
Mark T. Paden 47 President, Chief Operating Officer, Compensation Committee Member
and Director.
Brenda B. Watson 63 Executive Vice President of NAICO.
Richard L. Evans 57 Senior Vice President and Director.
R. Patrick Gilmore 52 Senior Vice President, Secretary, General Counsel and Director.
Mark C. Hart 48 Vice President - Finance, Chief Financial Officer and Treasurer.
M. Steven Blain 46 Vice President - Administration.
Robert L. Rice 69 Audit Committee Chairman and Director.
W. Scott Martin 53 Audit Committee Member and Director.
K.R. Price 66 Audit Committee Member and Director.
William T. Keele 67 Director.
W. BRENT LAGERE has been a director, Chairman of the Board and Chief
Executive Officer of Chandler USA since 1988. 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 and
was a director of Chandler Barbados until December 2003.
PAGE 30
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 since May 1998.
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 and NAICO since November 1992.
Mr. Paden also serves as a director and President of Chandler Insurance.
BRENDA B. WATSON has been Executive Vice President of NAICO since August
1987. Since October 1988, she has served in officer and director capacities
for various subsidiaries of Chandler USA pursuant to an employment contract
with Chandler USA. Ms. Watson also serves as Executive Vice President of
Chandler Insurance.
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.
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 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 also serves as Vice
President-Accounting, Chief Financial Officer and Treasurer of Chandler
Insurance.
M. STEVEN BLAIN has served as Vice President-Administration 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, First National Bank in Burkburnett, Texas and
The Bank of Union in Union City, Oklahoma.
K. R. PRICE has been a director of Chandler USA and NAICO since May 2001.
Mr. Price has been a stockbroker for Raymond James Financial Services, Inc.
since April 1997, and was Executive Vice President and a director for Southwest
Securities, Inc. from 1974 until April 1997.
WILLIAM T. KEELE has been a director of Chandler USA and NAICO since May
2001. Mr. Keele has been President of Hallman & Keele, Inc., a construction
and steel fabrication firm, since 1974.
AUDIT COMMITTEE FINANCIAL EXPERT
Chandler USA's Board of Directors has determined that Robert L. Rice,
Chairman of the Audit Committee, is an "audit committee financial expert", as
defined by Securities and Exchange Commission rules. Mr. Rice is an
independent director, as that term is used in Item 7(d)(3)(IV) of Schedule 14A
under the Securities Exchange Act of 1934.
CODE OF ETHICS
Chandler USA has adopted a Code of Ethics for Principal Executive and
Senior Financial Officers, a copy of which is filed as Exhibit 14.1 to this
Form 10-K.
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,
2003.
PAGE 31
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth the compensation paid or to be paid by
Chandler USA or any of its subsidiaries as well as certain other compensation
paid or accrued, during the years indicated, to the Chairman and Chief
Executive Officer and the four other highest paid executive officers of
Chandler USA and its subsidiaries (the "Named Executives") for such period in
all capacities in which they served.
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION (1)
-------------------------------------------------------
OTHER ANNUAL ALL OTHER
SALARY BONUS COMPENSATION COMPENSATION
NAME AND PRINCIPAL POSITION YEAR ($) ($)(2) ($)(3) ($)(4)
- --------------------------------------- -------- ---------- ---------- ------------ ------------
W. Brent LaGere 2003 $ 489,602 $ 574,456 $ 795,994 $ 94,131
Chairman of the Board and CEO 2002 458,723 484,120 348,172 49,332
of Chandler USA and NAICO 2001 420,451 305,000 153,668 46,381
Mark T. Paden 2003 304,654 395,427 73,934 7,133
President and COO of Chandler USA 2002 295,481 403,348 77,861 5,749
and NAICO 2001 278,668 225,000 N/A 5,502
Brenda B. Watson 2003 254,072 - N/A 18,860
Executive Vice President 2002 244,448 - N/A 11,526
of NAICO 2001 238,904 - N/A 10,372
Richard L. Evans 2003 254,875 - N/A 9,866
Senior Vice President - Claims of 2002 245,899 4,500 N/A 7,928
Chandler USA and NAICO 2001 238,713 - N/A 7,261
R. Patrick Gilmore 2003 224,154 - N/A 7,240
Senior Vice President, Secretary and 2002 216,790 - N/A 5,405
General Counsel of Chandler USA 2001 210,460 - N/A 3,837
and NAICO
- ----------------------------------------
(1) Amounts shown include cash and non-cash compensation earned and received by the Named
Executives as well as amounts earned but deferred at their election.
(2) All Named Executives are eligible to receive bonuses based upon various factors.
(3) The amounts shown under this column represent various perquisites and other personal
benefits including any associated tax reimbursements to the Named Executives. Amounts
that did not exceed the lesser of $50,000 or 10% of the total annual salary and bonus for
any Named Executive have been excluded. Substantially all of the amounts shown in this
column represent payment of various personal expenses, none of which individually exceeded
25% of total perquisites for the Named Executive. Tax gross-ups for the personal expenses
included in the amounts shown above were $43,925, $167,145 and $366,902 for Mr. LaGere in
2001, 2002 and 2003, respectively, and $33,231 and $32,996 for Mr. Paden in 2002 and 2003,
respectively.
(4) The amounts shown under this column include contributions by Chandler USA's subsidiaries to
a 401(k) plan ($4,187 for Mr. LaGere, $3,688 for Mr. Paden, $4,600 for Ms. Watson, $3,850
for Mr. Evans, and $4,000 for Mr. Gilmore), and the premiums paid or to be paid by Chandler
USA's subsidiaries under life insurance arrangements with the Named Executives. A portion
of the premiums ($31,300, $33,600 and $44,453 in 2001, 2002 and 2003, respectively) were
paid under a split dollar life insurance plan. Under this plan, Chandler USA's
subsidiaries pay the premiums for life insurance issued to the Named Executive. Repayment
of the premiums is secured by the death benefit or the cash surrender value of the policy,
if any, if the Named Executive cancels and surrenders the policy.
PAGE 32
OPTIONS EXERCISED AND HOLDINGS
No options were granted to or exercised by the Named Executives during
2003 and there were no unexercised options held by the Named Executives as of
December 31, 2003.
DIRECTOR COMPENSATION
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. 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.
EMPLOYMENT AGREEMENTS
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.
Chandler USA had an employment agreement with Brenda B. Watson, an
executive officer of NAICO. Under this agreement, Ms. Watson's base
compensation was established at not less than $125,000 per year. The agreement
terminated on December 31, 2003. In addition to her base compensation, Ms.
Watson is eligible to receive certain benefits and bonuses from Chandler USA
and its subsidiaries.
PAGE 33
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
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 29, 2004, are beneficially owned by (i) each director of Chandler USA
and Chandler Insurance, (ii) Chandler USA's Chairman and Chief Executive
Officer and each of Chandler USA's four other most highly compensated executive
officers for services rendered for the fiscal year ended December 31, 2003 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 75,152 18.8%
Mark T. Paden ............................................ Class A Common Shares 125,165 20.0%
Series A Preferred Shares 17,610 4.4%
Brenda B. Watson (4) ..................................... Series A Preferred Shares 18,024 4.5%
Series B Preferred Shares 35,542 8.5%
Richard L. Evans ......................................... Series A Preferred Shares 27,272 6.8%
Series B Preferred Shares 32,250 7.7%
R. Patrick Gilmore ....................................... Series B Preferred Shares 11,000 2.6%
Robert L. Rice ........................................... - - -%
W. Scott Martin .......................................... Series C Preferred Shares 31,500 4.6%
K.R. Price (5) ........................................... Series C Preferred Shares 136,200 19.9%
William T. Keele (6) ..................................... Series C Preferred Shares 122,417 17.9%
Steven R. Butler (7) ..................................... Series C Preferred Shares 3,200 *%
All directors and officers as a group (11 persons) (8) ... Class A Common Shares 625,826 100.0%
Series A Preferred Shares 141,586 35.5%
Series B Preferred Shares 78,792 18.8%
Series C Preferred Shares 293,317 42.8%
- ----------------------------------------------------------
* Less than 1%
(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, 399,061 Series A Preferred
Shares of Chandler Insurance, 418,853 Series B Preferred Shares of Chandler Insurance and
684,569 Series C Preferred Shares of Chandler Insurance outstanding on February 29, 2004.
(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. Mr. LaGere holds an irrevocable proxy for the Class A Common
Shares owned by the LaGere Trust and W&L Holding. Mr. LaGere disclaims beneficial
ownership of the shares held by the LaGere Trust and W&L Holding. The business address of
Mr. LaGere is 1010 Manvel Avenue, Chandler, Oklahoma 74834.
(4) Includes 8,027 Series A Preferred Shares of Chandler Insurance held by Ms. Watson's
husband. Ms. Watson disclaims beneficial ownership of the shares owned by her husband.
(5) Includes 11,500 Series C Preferred Shares of Chandler Insurance held by Mr. Price's wife.
Mr. Price disclaims beneficial ownership of these shares.
(6) Includes 63,787 Series C Preferred Shares of Chandler Insurance held by the Keele Family
Ltd. Partnership, 4,062 shares held by Mr. Keele's wife and 23,911 shares held by Mr.
Keele's children. Mr. Keele disclaims beneficial ownership of the shares owned by his wife
and children.
(7) Mr. Butler is a director, Vice President - Administration and Secretary of Chandler
Insurance, and also served as a director and President of Chandler Barbados until December
2003.
(8) Includes 3,528 Series A Preferred Shares of Chandler Insurance owned by one executive
officer of Chandler USA not listed in the table above.
PAGE 34
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 29, 2004. 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
---------------------------------------
NAME OF SHAREHOLDER NUMBER OF SHARES (1) PERCENT (2)
- -------------------------------------------------------- ---------------------- ---------------
Malinda Laird, Matthew LaGere and Lance LaGere, Trustees
of the W. Brent LaGere Irrevocable Trust
1010 Manvel Avenue, Chandler, Oklahoma 74834 ......... 370,890 (3) 59.3%
- --------------------------------------------------------
(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.
(2) Based on 625,826 Class A Common Shares of Chandler Insurance outstanding on February 29,
2004.
(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. Mr. LaGere holds an irrevocable proxy for the Class A Common Shares
owned by the LaGere Trust and W&L Holding.
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
Chandler USA leases a rural property from Davenport Farms, Inc.
("Davenport Farms"), a corporation owned by Messrs. LaGere, Evans and 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 maintains 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
hunting supplies. 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 2001, 2002 and 2003, Chandler USA incurred approximately
$263,000, $255,000 and $336,000, respectively, in expenses associated with its
use of this property, including $25,000, $18,000 and $12,000 for reimbursement
of certain expenses, such as utility and similar expenses, for the years 2001,
2002 and 2003, respectively.
NAICO purchases and sells investment securities through various brokerage
firms including Raymond James & Associates, Inc., a subsidiary of Raymond James
Financial, Inc. K.R. Price is employed by Raymond James Financial Services,
Inc. which is also a subsidiary of Raymond James Financial, Inc. Since May
2001, Mr. Price has been a director of NAICO and Chandler USA. Mr. Price
receives no compensation from NAICO's investment transactions since joining the
boards in May 2001.
During the fourth quarter of 2002, Chandler USA's board of directors
approved the cancellation and release of certain judgments against three
directors of Chandler USA and one executive officer of NAICO that resulted from
the CenTra litigation. The amounts canceled included $233,122 for Mr. LaGere,
$136,467 for Ms. Watson, $99,338 for Mr. Evans and $72,142 for Mr. Paden. The
board's action followed a ruling during August 2002 by the U.S. District Court
for the Western District of Oklahoma denying CenTra's claim for post-judgment
interest from Chandler Insurance of approximately $2.5 million.
PAGE 35
Chandler USA believes that all transactions with directors, officers, or
shareholders of Chandler USA and its subsidiaries are and will continue to be
on terms no less favorable to Chandler USA and its subsidiaries than could be
obtained from unaffiliated parties.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
AUDIT FEES
The aggregate audit fees billed or to be billed by Tullius Taylor Sartain
& Sartain 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 $146,700 and
$149,600 for the years ended December 31, 2002 and 2003, respectively.
AUDIT-RELATED FEES
The aggregate fees billed for professional services rendered by Tullius
Taylor Sartain & Sartain LLP for audit related services rendered in connection
with the audits of employee benefit plans and consultation on accounting
standards or transactions were $20,500 and $18,675 for the years ended December
31, 2002 and 2003, respectively.
TAX FEES
The aggregate fees billed or to be billed for professional services
rendered by Tullius Taylor Sartain & Sartain LLP for tax compliance, tax advice
and tax planning were $40,430 and $26,375 for the years ended December 31, 2002
and 2003, respectively.
ALL OTHER FEES
The aggregate fees billed by Tullius Taylor Sartain & Sartain LLP for
professional services other than those reported in the categories above were
$6,300 and $1,446 for the years ended December 31, 2002 and 2003, respectively.
POLICY ON PRE-APPROVAL OR RETENTION OF INDEPENDENT AUDITORS
All audit and permitted non-audit services for which Chandler USA engages
Tullius Taylor Sartain & Sartain LLP require pre-approval by Chandler USA's
Audit Committee. The percentage of Audit-Related Fees, Tax Fees and All Other
Fees out of all fees paid to Tullius Taylor Sartain & Sartain LLP was 31.4% and
23.7% for the years ended December 31, 2002 and 2003, respectively.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. FINANCIAL STATEMENTS. The consolidated balance sheets of Chandler
USA and its subsidiaries as of December 31, 2002 and 2003, 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, 2003, together with the related notes
thereto and the report of Tullius Taylor Sartain & Sartain 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.
PAGE 36
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)
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.
10.12 Indenture, dated as of December 16, 2003 among Chandler
(U.S.A.), Inc., as issuer, and Wilmington Trust Company, as
trustee.
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.
PAGE 37
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 I, Ltd., as
purchaser.
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.
14.1 Code of Ethics.
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.
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.
(b) Reports on Form 8-K.
Chandler USA filed one current report on Form 8-K dated December 1, 2003
responding to Item 5 of Form 8-K.
PAGE 38
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, 2004 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, 2004 /s/ W. Brent LaGere
-------------------------------------------------------
W. Brent LaGere, Chairman of the Board,
Chief Executive Officer and Director
(Principal Executive Officer)
Date: March 2, 2004 /s/ Mark T. Paden
-------------------------------------------------------
Mark T. Paden, President, Chief Operating Officer
and Director
Date: March 2, 2004 /s/ Mark C. Hart
-------------------------------------------------------
Mark C. Hart, Vice President - Finance,
Chief Financial Officer and Treasurer
(Principal Financial Officer)
Date: March 2, 2004 /s/ Richard L. Evans
-------------------------------------------------------
Richard L. Evans, Senior Vice President and Director
Date: March 2, 2004 /s/ R. Patrick Gilmore
-------------------------------------------------------
R. Patrick Gilmore, Senior Vice President,
Secretary, General Counsel and Director
Date: March 2, 2004 /s/ Robert L. Rice
-------------------------------------------------------
Robert L. Rice, Director
Date: March 2, 2004 /s/ W. Scott Martin
-------------------------------------------------------
W. Scott Martin, Director
Date: March 2, 2004 /s/ K.R. Price
-------------------------------------------------------
K.R. Price, Director
Date: March 2, 2004 /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, 2002 and 2003 ................. F-2
Consolidated Statements of Operations for the years ended
December 31, 2001, 2002 and 2003 ........................................... F-3
Consolidated Statements of Comprehensive Income for the years ended
December 31, 2001, 2002 and 2003 ........................................... F-4
Consolidated Statements of Cash Flows for the years ended
December 31, 2001, 2002 and 2003 ........................................... F-5
Consolidated Statements of Shareholder's Equity for the years ended
December 31, 2001, 2002 and 2003 ........................................... F-6
Notes to Consolidated Financial Statements ................................... F-7 through F-25
Independent Auditors' Report on Consolidated Financial Statements
and Financial Statement Schedules .......................................... F-26
SCHEDULES
I Summary of Investments - Other Than Investments in Related Parties ...... F-27
II Condensed Financial Information of Registrant ........................... F-28 through F-30
III Supplementary Insurance Information ..................................... F-31
IV Reinsurance ............................................................. F-32
V Valuation and Qualifying Accounts ....................................... F-33
VI Supplemental Information (for property-casualty insurance underwriters).. F-34
PAGE F-2
CHANDLER (U.S.A.), INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands except share amounts)
DECEMBER 31,
----------------------
2002 2003
---------- ----------
ASSETS
Investments
Fixed maturities available for sale, at fair value
Restricted (amortized cost $6,737 and $7,622 in 2002 and 2003, respectively) ....... $ 6,943 $ 7,677
Unrestricted (amortized cost $48,362 and $53,549 in 2002 and 2003, respectively) ... 50,096 54,303
Fixed maturities held to maturity, at amortized cost
Restricted (fair value $394 in 2002) ............................................... 374 -
Unrestricted (fair value $895 in 2002) ............................................. 846 -
Equity securities available for sale, at fair value .................................. 681 92
---------- ----------
Total investments .................................................................. 58,940 62,072
Cash and cash equivalents ($711 and $601 restricted in 2002 and 2003, respectively) .... 9,336 7,126
Premiums receivable, less allowance for non-collection
of $246 and $133 at 2002 and 2003, respectively ...................................... 24,009 20,304
Reinsurance recoverable on paid losses, less allowance for non-collection
of $2,275 and $2,934 at 2002 and 2003, respectively .................................. 11,198 9,036
Reinsurance recoverable on paid losses from related parties ............................ 80 271
Reinsurance recoverable on unpaid losses, less allowance for non-collection
of $492 and $380 at 2002 and 2003 .................................................... 50,377 48,688
Reinsurance recoverable on unpaid losses from related parties .......................... 9,038 9,737
Prepaid reinsurance premiums ........................................................... 19,202 15,269
Prepaid reinsurance premiums to related parties ........................................ 8,680 9,521
Deferred policy acquisition costs ...................................................... 355 165
Property and equipment, net ............................................................ 10,093 9,879
Amounts due from related parties ....................................................... 10,582 9,642
State insurance licenses, net .......................................................... 3,745 3,745
Other assets ........................................................................... 14,220 12,138
---------- ----------
Total assets ........................................................................... $ 229,855 $ 217,593
========== ==========
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Unpaid losses and loss adjustment expenses ........................................... $ 92,606 $ 87,768
Unearned premiums .................................................................... 55,160 47,325
Policyholder deposits ................................................................ 4,244 4,807
Accrued taxes and other payables ..................................................... 8,040 5,617
Premiums payable ..................................................................... 2,805 983
Debentures ........................................................................... 24,000 7,254
Trust preferred securities ........................................................... - 20,000
---------- ----------
Total liabilities .................................................................. 186,855 173,754
---------- ----------
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 .................................................................. (19,316) (17,342)
Accumulated other comprehensive income:
Unrealized gain on investments available for sale, net of deferred income taxes .... 1,730 595
---------- ----------
Total shareholder's equity ......................................................... 43,000 43,839
---------- ----------
Total liabilities and shareholder's equity ............................................. $ 229,855 $ 217,593
========== ==========
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,
--------------------------------
2001 2002 2003
---------- ---------- ----------
Premiums and other revenues
Direct premiums written and assumed ........................ $ 158,964 $ 140,162 $ 118,444
Reinsurance premiums ceded ................................. (70,086) (48,380) (40,612)
Reinsurance premiums ceded to related parties .............. (23,455) (24,115) (25,992)
---------- ---------- ----------
Net premiums written and assumed ......................... 65,423 67,667 51,840
Decrease (increase) in unearned premiums ................... 4,562 (710) 4,743
---------- ---------- ----------
Net premiums earned ...................................... 69,985 66,957 56,583
Interest income, net ......................................... 3,632 2,540 2,148
Interest income, net from related parties .................... 371 380 412
Realized investment gains, net ............................... 2,654 794 2,351
Other income ................................................. 101 261 5,077
---------- ---------- ----------
Total premiums and other revenues ........................ 76,743 70,932 66,571
---------- ---------- ----------
Operating costs and expenses
Losses and loss adjustment expenses, net of amounts ceded
to related parties of $15,712, $16,936 and $14,244
in 2001, 2002 and 2003, respectively ..................... 52,550 50,712 37,200
Policy acquisition costs, net of ceding commissions received
from related parties of $8,029, $8,199 and $8,770
in 2001, 2002 and 2003, respectively ..................... 10,869 10,239 11,278
General and administrative expenses ........................ 11,549 12,473 13,486
Interest expense ........................................... 2,240 2,234 2,441
---------- ---------- ----------
Total operating costs and expenses ....................... 77,208 75,658 64,405
---------- ---------- ----------
Income (loss) from continuing operations before income taxes.. (465) (4,726) 2,166
Federal income tax benefit (provision) ....................... (16) 1,680 (192)
---------- ---------- ----------
Income (loss) from continuing operations ..................... (481) (3,046) 1,974
Income (loss) from discontinued operations ................... (622) 284 -
Gain on sale of subsidiary ................................... - 671 -
---------- ---------- ----------
Net income (loss) .......................................... $ (1,103) $ (2,091) $ 1,974
========== ========== ==========
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,
--------------------------------
2001 2002 2003
---------- ---------- ----------
Net income (loss) .............................................................. $ (1,103) $ (2,091) $ 1,974
---------- ---------- ----------
Other comprehensive income (loss), before income tax:
Unrealized gains on securities:
Unrealized holding gains arising during period ............................. 2,644 2,838 631
Less: Reclassification adjustment for gains included in net income (loss) .. (2,654) (794) (2,351)
---------- ---------- ----------
Other comprehensive income (loss), before income tax ........................... (10) 2,044 (1,720)
Income tax benefit (provision) related to items of other
comprehensive income (loss) .................................................. 4 (695) 585
---------- ---------- ----------
Other comprehensive income (loss), net of income tax ........................... (6) 1,349 (1,135)
---------- ---------- ----------
Comprehensive income (loss) .................................................... $ (1,109) $ (742) $ 839
========== ========== ==========
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,
--------------------------------
2001 2002 2003
---------- ---------- ----------
OPERATING ACTIVITIES
Net income (loss) .................................................... $ (1,103) $ (2,091) $ 1,974
Add (deduct):
Adjustments to reconcile net income (loss) to cash
applied to operating activities:
Realized investment gains, net ................................... (2,654) (794) (2,351)
Gain on sale of subsidiary ....................................... - (671) -
Gain on retirement of debentures ................................. - - (3,106)
Net (gains) losses on sale of property and equipment ............. 23 32 (1,661)
Amortization and depreciation .................................... 2,169 1,602 1,470
Provision for non-collection of premiums ......................... 305 444 272
Provision for non-collection of reinsurance recoverables ......... 454 1,726 604
Net change in non-cash balances relating to operating activities:
Premiums receivable ............................................ 9,029 (268) 3,433
Reinsurance recoverable on paid losses ......................... (9,396) (712) 1,449
Reinsurance recoverable on paid losses from related parties .... 322 212 (191)
Reinsurance recoverable on unpaid losses ....................... (2,689) (8,288) 1,798
Reinsurance recoverable on unpaid losses from related parties .. 4,680 361 (699)
Prepaid reinsurance premiums ................................... 5,809 7,688 3,933
Prepaid reinsurance premiums to related parties ................ 2,265 (577) (841)
Deferred policy acquisition costs .............................. - (355) 190
Other assets ................................................... 1,906 (1,349) 2,427
Unpaid losses and loss adjustment expenses ..................... (15,417) 7,850 (4,838)
Unearned premiums ................................... .......... (12,636) (6,402) (7,835)
Policyholder deposits .......................................... (462) (356) 563
Accrued taxes and other payables ............................... (1,248) 307 (752)
Premiums payable ............................................... (9,138) (5,864) (1,822)
---------- ---------- ----------
Cash applied to operating activities ............................. (27,781) (7,505) (5,983)
---------- ---------- ----------
INVESTING ACTIVITIES
Unrestricted fixed maturities available for sale:
Purchases .......................................................... (61,448) (23,163) (33,378)
Sales .............................................................. 73,107 31,460 22,806
Maturities ......................................................... 14,297 4,339 5,892
Equity securities available for sale:
Sales .............................................................. - - 1,720
Cost of property and equipment purchased ............................. (1,356) (373) (818)
Proceeds from sale of property and equipment ......................... 3,924 98 104
Net proceeds from sale of subsidiary ................................. - 3,058 -
---------- ---------- ----------
Cash provided by (applied to) investing activities ............... 28,524 15,419 (3,674)
---------- ---------- ----------
FINANCING ACTIVITIES
Proceeds from issuance of trust preferred securities ................. - - 20,000
Payment on retirement of debentures .................................. - - (12,782)
Debt issue costs ..................................................... - - (711)
Payments and loans from related parties .............................. 4,032 3,249 2,426
Payments and loans to related parties ................................ (12,629) (5,951) (1,486)
---------- ---------- ----------
Cash provided by (applied to) financing activities ............... (8,597) (2,702) 7,447
---------- ---------- ----------
Increase (decrease) in cash and cash equivalents during the period ... (7,854) 5,212 (2,210)
Cash and cash equivalents at beginning of period ..................... 11,978 4,124 9,336
---------- ---------- ----------
Cash and cash equivalents at end of period ........................... $ 4,124 $ 9,336 $ 7,126
========== ========== ==========
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 equity
----------- ----------- ----------- ------------- -------------
Balance, January 1, 2001 ................ $ 2 $ 60,584 $ (16,122) $ 387 $ 44,851
Net loss ................................ - - (1,103) - (1,103)
Change in unrealized gain on
investments available for
sale, net of income tax ............... - - - (6) (6)
----------- ----------- ----------- ------------- -------------
Balance, December 31, 2001 .............. 2 60,584 (17,225) 381 43,742
----------- ----------- ----------- ------------- -------------
Net loss ................................ - - (2,091) - (2,091)
Change in unrealized gain on
investments available for
sale, net of income tax ............... - - - 1,349 1,349
----------- ----------- ----------- ------------- -------------
Balance, December 31, 2002 .............. 2 60,584 (19,316) 1,730 43,000
----------- ----------- ----------- ------------- -------------
Net income .............................. - - 1,974 - 1,974
Change in unrealized gain on
investments available for
sale, net of income tax ............... - - - (1,135) (1,135)
----------- ----------- ----------- ------------- -------------
Balance, December 31, 2003 .............. $ 2 $ 60,584 $ (17,342) $ 595 $ 43,839
=========== =========== =========== ============= =============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
PAGE F-7
CHANDLER (U.S.A.), INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
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 coverage 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 USA is wholly owned by Chandler Insurance Company, Ltd.
("Chandler Insurance"), a Cayman Islands company. Prior to December
2003, Chandler USA was a wholly owned subsidiary of Chandler Insurance
(Barbados), Ltd. ("Chandler Barbados") which, in turn, was a wholly
owned subsidiary of Chandler Insurance. In December 2003, Chandler
Barbados was dissolved following the transfer of its assets, liabilities
and business to Chandler Insurance. Chandler Insurance assumed the
obligations of Chandler Barbados including those under its reinsurance
agreements with NAICO pursuant to a Distribution Agreement and a General
Conveyance. The reorganization of Chandler Barbados and Chandler
Insurance was approved by the Cayman Islands Monetary Authority, the
Supervisor of Insurance in Barbados and the Oklahoma Insurance
Department.
In December 2002, Chandler USA completed the sale of its wholly
owned subsidiary LaGere and Walkingstick Insurance Agency, Inc. ("L&W").
L&W previously functioned as Chandler USA's agency segment. All periods
have been restated to reflect the results of L&W as a discontinued
operation. See Note 4 for more information on the sale of L&W.
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 including NAICO. 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 and premiums are
billed.
PAGE F-8
(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.
(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 3, 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.
NAICO accrued $143,000, $105,000 and a credit of $52,000 during 2001,
2002 and 2003, respectively, for dividends to policyholders primarily
on participating workers compensation policies. Gross written premiums
for participating policies were $1.2 million, $615,000 and $50,000 in
2001, 2002 and 2003, respectively.
(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:
2002 2003
---------- ----------
(In thousands)
Real estate and improvements .. $ 10,411 $ 10,689
Other property and equipment .. 8,870 9,219
---------- ----------
19,281 19,908
Accumulated depreciation ...... (9,188) (10,029)
---------- ----------
$ 10,093 $ 9,879
========== ==========
Depreciation expense from continuing operations was approximately
$1,016,000, $916,000 and $918,000 for 2001, 2002 and 2003, respectively.
PAGE F-9
(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. Goodwill was
amortized using the straight-line method over 15-17 years. Effective
January 1, 2002, goodwill and the state insurance licenses are no longer
amortized but reviewed at least annually for impairment. Chandler USA
completed the required impairment tests during 2002 and 2003 and
concluded that there has not been an impairment loss since the fair
values exceeded their respective carrying values. The fair values were
determined based on the present value of projected future net cash flows.
All of Chandler USA's goodwill pertained to the agency operating segment
and was written off in 2002 following the sale of L&W. Intangible
assets included the following at December 31:
2002 2003
---------- ----------
(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.
(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 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. Securities not
classified as held to maturity or trading 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 investment 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.
PAGE F-10
(n) SUPPLEMENTAL CASH FLOW INFORMATION
Cash payments for interest and income taxes, and noncash investing
activities were as follows:
YEAR ENDED DECEMBER 31,
--------------------------------
2001 2002 2003
---------- ---------- ----------
(In thousands)
Cash payments (refunds) during the year for:
Interest ...................................... $ 2,128 $ 2,122 $ 2,809
Income taxes .................................. (1,025) (1,241) (300)
Transfers from (to) restricted securities, net .. $ (146) $ (1,341) $ (563)
(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.
(p) NEW ACCOUNTING STANDARDS
The Financial Accounting Standards Board ("FASB") periodically
issues new accounting standards in a continuing effort to improve
standards of financial accounting and reporting. Chandler USA has
reviewed the recently issued pronouncements and concluded that the
following new accounting standards are applicable to Chandler USA.
In June 2001, the FASB issued Statement of Financial Accounting
Standards ("SFAS") No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS. SFAS
No. 142 supercedes Accounting Principles Board ("APB") Opinion No. 17,
INTANGIBLE ASSETS, and primarily addresses accounting for goodwill and
intangible assets subsequent to acquisition. Under SFAS No. 142,
goodwill and separately identified intangible assets with indefinite
lives will no longer be amortized but reviewed annually (or more
frequently if impairment indicators arise) for impairment. Separately
identified intangible assets not deemed to have indefinite lives will
continue to be amortized over their useful lives. Chandler USA adopted
SFAS No. 142 effective January 1, 2002. Chandler USA completed the
required impairment tests during 2002 and 2003 and concluded that there
has not been an impairment. The fair values were determined based on
the present value of projected future net cash flows. All of Chandler
USA's goodwill pertained to the agency operating segment and was written
off in the fourth quarter of 2002 following the sale of L&W.
A reconciliation of the reported income (loss) from continuing
operations to the adjusted income (loss) from continuing operations had
SFAS No. 142 been applied as of January 1, 2001 follows:
YEAR ENDED DECEMBER 31,
--------------------------------
2001 2002 2003
---------- ---------- ----------
(In thousands)
Reported income (loss) from continuing operations .. $ (481) $ (3,046) $ 1,974
Add back amortization:
State insurance licenses ......................... 150 - -
---------- ---------- ----------
Adjusted income (loss) from continuing operations .. $ (331) $ (3,046) $ 1,974
========== ========== ==========
In August 2001, the FASB issued SFAS No. 144, ACCOUNTING FOR THE
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS. SFAS No. 144 supercedes
SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND
FOR LONG-LIVED ASSETS TO BE DISPOSED OF, and APB Opinion No. 30,
REPORTING THE RESULTS OF OPERATIONS - REPORTING THE EFFECTS OF DISPOSAL
OF A SEGMENT OF A BUSINESS, AND EXTRAORDINARY, UNUSUAL AND INFREQUENTLY
OCCURRING EVENTS AND TRANSACTIONS. SFAS No. 144 establishes an
accounting model based on SFAS No. 121 for long-lived assets to be
disposed of by sale, previously accounted for under APB Opinion No. 30.
Chandler USA adopted SFAS No. 144 effective January 1, 2002. The
adoption of SFAS No. 144 did not have a material impact on Chandler
USA's consolidated financial condition, results of operations or cash
flows.
PAGE F-11
In June 2002, the FASB issued SFAS No. 146, ACCOUNTING FOR COSTS
ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES. This standard requires
entities to recognize a liability, at its fair value, associated with
exit or disposal activities when they are incurred rather than at the
date of a commitment to an exit or disposal plan. Chandler USA adopted
SFAS No. 146 effective January 1, 2002. The adoption of SFAS No. 146
did not have a material impact on Chandler USA's consolidated financial
statements, results of operations or cash flows.
In November 2002, the FASB issued FASB Interpretation No. 45,
GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENTS FOR GUARANTEES,
INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS. The
Interpretation elaborates on the disclosures to be made by a guarantor
in its interim and annual financial statements about its obligations
under certain guarantees that it has issued. It also requires a
guarantor to recognize, at the inception of a guarantee, a liability for
the fair value of the obligation undertaken in issuing the guarantee.
The initial recognition and measurement provisions of the Interpretation
apply to guarantees issued or modified after December 31, 2002. The
adoption of this accounting pronouncement did not have a material effect
on Chandler USA's financial position or results of operations.
In January 2003, the FASB issued Interpretation No. 46,
CONSOLIDATION OF VARIABLE INTEREST ENTITIES. The Interpretation
requires an investor with a majority of the variable interests in a
variable interest entity to consolidate the entity and also requires
majority and significant variable interest investors to provide certain
disclosures. A variable interest entity is an entity in which the
equity investors do not have a controlling interest or the equity
investment at risk is insufficient to finance the entity's activities
without receiving additional subordinated financial support from the
other parties. This pronouncement requires the consolidation of
variable interest entities created after January 31, 2003.
Consolidation provisions apply for periods ending after March 15, 2004
for variable interest entities, other than special purpose entities,
created prior to February 1, 2003. Chandler USA does not have any
variable interest entities, including special purpose entities, that
must be consolidated and therefore the adoption of this accounting
pronouncement will not have an impact on Chandler USA's financial
position or results of operations.
In May 2003, the FASB issued SFAS No. 150, ACCOUNTING FOR CERTAIN
FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND
EQUITY. SFAS No. 150 establishes standards for how an issuer classifies
and measures certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances). Many of those instruments were previously classified as
equity. SFAS No. 150 is effective for financial instruments entered
into or modified after May 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after September 15,
2003. During 2003, Chandler USA issued trust preferred securities
through two wholly owned subsidiaries and has accounted for the trust
preferred securities as a liability in accordance with SFAS No. 150.
NOTE 2. INVESTMENTS AND INTEREST INCOME
Net interest income and realized investment gains from continuing
operations are summarized in the following table. These amounts are net of
investment expenses.
YEAR ENDED DECEMBER 31,
--------------------------------
2001 2002 2003
---------- ---------- ----------
(In thousands)
Interest on fixed-maturity investments ................. $ 4,406 $ 2,755 $ 2,271
Interest on cash equivalents ........................... 555 252 139
Interest on amounts due from related parties ........... 371 380 412
Investment expenses .................................... (1,329) (467) (262)
---------- ---------- ----------
Interest income, net ................................. 4,003 2,920 2,560
---------- ---------- ----------
Realized gains, net - fixed-maturity investments ....... 2,654 794 631
Realized gains, net - equity securities ................ - - 1,720
---------- ---------- ----------
Realized investments gains, net ...................... 2,654 794 2,351
---------- ---------- ----------
$ 6,657 $ 3,714 $ 4,911
========== ========== ==========
Investment expenses include $997,000, $244,000 and $81,000 for the years
ended December 31, 2001, 2002 and 2003, respectively, in expense to subsidize a
premium finance program for certain insureds of NAICO with an unaffiliated
premium finance company.
PAGE F-12
The amortized cost of fixed maturities or cost of equity securities, gross
unrealized gains or losses, fair value and carrying value of investments are as
follows:
GROSS GROSS
UNREALIZED UNREALIZED FAIR CARRYING
DECEMBER 31, 2002 COST GAINS LOSSES VALUE VALUE
- ---------------------------------------- ---------- ---------- ---------- ---------- ----------
FIXED MATURITIES AVAILABLE FOR SALE: (In thousands)
U.S. Treasury securities and obligations
of U.S. government corporations
and agencies ......................... $ 37,135 $ 1,348 $ - $ 38,483 $ 38,483
Corporate obligations .................. 11,173 357 (5) 11,525 11,525
Public utilities ....................... 6,791 258 (18) 7,031 7,031
---------- ---------- ---------- ---------- ----------
$ 55,099 $ 1,963 $ (23) $ 57,039 $ 57,039
========== ========== ========== ========== ==========
FIXED MATURITIES HELD TO MATURITY:
U.S. Treasury securities and obligations
of U.S. government corporations
and agencies ......................... $ 1,220 $ 69 $ - $ 1,289 $ 1,220
========== ========== ========== ========== ==========
EQUITY SECURITIES AVAILABLE FOR SALE:
Corporate stock ........................ $ - $ 681 $ - $ 681 $ 681
========== ========== ========== ========== ==========
GROSS GROSS
UNREALIZED UNREALIZED FAIR CARRYING
DECEMBER 31, 2003 COST GAINS LOSSES VALUE VALUE
- ---------------------------------------- ---------- ---------- ---------- ---------- ----------
FIXED MATURITIES AVAILABLE FOR SALE: (In thousands)
U.S. Treasury securities and obligations
of U.S. government corporations
and agencies ......................... $ 38,565 $ 587 $ (141) $ 39,011 $ 39,011
Corporate obligations .................. 11,645 313 (90) 11,868 11,868
Public utilities ....................... 6,816 220 (20) 7,016 7,016
Mortgage-backed securities ............. 4,145 - (60) 4,085 4,085
---------- ---------- ---------- ---------- ----------
$ 61,171 $ 1,120 $ (311) $ 61,980 $ 61,980
========== ========== ========== ========== ==========
EQUITY SECURITIES AVAILABLE FOR SALE:
Corporate stock ........................ $ - $ 92 $ - $ 92 $ 92
========== ========== ========== ========== ==========
The fair value of Chandler USA's investments with gross unrealized losses
at December 31, 2003 is presented below:
FAIR UNREALIZED
VALUE LOSSES
----------- ----------
(In thousands)
U.S. Treasury securities and obligations of U.S. Government
corporations and agencies .................................. $ 7,513 $ (141)
Corporate obligations ........................................ 2,996 (90)
Public utilities ............................................. 1,653 (20)
Mortgage-backed securities ................................... 4,085 (60)
----------- ----------
$ 16,247 $ (311)
=========== ==========
At December 31, 2003, none of Chandler USA's investments had been in a
continuous unrealized loss position for 12 months or more. 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 issuers, 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 has concluded that the declines in the fair values of
Chandler USA's investments at December 31, 2003 are temporary.
PAGE F-13
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, 2003 are shown below:
AVAILABLE FOR SALE
------------------------
AMORTIZED
COST FAIR VALUE
------------ ----------
(In thousands)
Due in one year or less ...................... $ 4,561 $ 4,634
Due after one year through five years ........ 33,154 33,957
Due after five years through ten years ....... 19,311 19,304
Due after ten years .......................... - -
------------ ----------
57,026 57,895
Mortgage-backed securities ................... 4,145 4,085
------------ ----------
$ 61,171 $ 61,980
============ ==========
Realized gains and losses from sales of investments are shown below:
GROSS REALIZED GAINS GROSS REALIZED LOSSES
-------------------- ---------------------
(In thousands)
FIXED MATURITIES:
2001 ............ $ 2,654 $ -
2002 ............ 904 110
2003 ............ 631 -
EQUITY SECURITIES:
2003 ............ 1,720 -
NAICO is required by several states to deposit securities with state
regulators as a condition of doing business in those states. Chandler USA
has deposited cash into a trust account as security related to certain
indemnification provisions related to its sale of L&W. As of December 31,
2002 and 2003, the carrying value of these deposits totaled approximately
$8.0 million and $8.3 million, respectively.
NOTE 3. 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 NAICO's net liability for unpaid losses and loss adjustment expenses were
approximately $5.6 million and $5.7 million at December 31, 2002 and 2003,
respectively. 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.
PAGE F-14
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,
--------------------------------
2001 2002 2003
---------- ---------- ----------
(In thousands)
Net balance at beginning of year ........................... $ 46,707 $ 32,812 $ 33,191
---------- ---------- ----------
Net losses and loss adjustment expenses incurred related to:
Current year ............................................ 39,881 34,928 26,108
Prior years ............................................. 12,669 15,784 11,092
---------- ---------- ----------
Total ................................................ 52,550 50,712 37,200
---------- ---------- ----------
Net paid losses and loss adjustment expenses related to:
Current year ............................................ (22,646) (13,283) (10,626)
Prior years ............................................. (43,799) (37,050) (30,422)
---------- ---------- ----------
Total ................................................ (66,445) (50,333) (41,048)
---------- ---------- ----------
Net balance at end of year ................................. $ 32,812 $ 33,191 $ 29,343
========== ========== ==========
During 2001, NAICO experienced incurred losses related to prior accident
years totaling $12.7 million due primarily to increased loss severity in the
standard property and casualty and political subdivisions programs. A
substantial part of this loss development was for workers compensation losses
in the 1999 accident year. NAICO's net retention for workers compensation
losses increased substantially in 1999 due to the rescission of certain
reinsurance treaties covering this line of business. Also contributing to the
adverse loss development were provisions for potentially uncollectible
reinsurance and deductibles of approximately $1.2 million during 2001, an
increase in losses in the surety bond program and approximately $878,000 in
losses for the runoff of a discontinued group accident and health program.
During 2002, NAICO experienced incurred losses related to prior accident
years totaling $15.8 million primarily in the standard property and casualty
program including both liability lines and workers compensation. This adverse
development is generally the result of ongoing analysis of recent loss
development trends that reflect an increase in loss severity within the
1997-2000 accident years. The adverse loss development included approximately
$2.0 million for provisions for potentially uncollectible reinsurance and
deductibles.
During 2003, NAICO experienced incurred losses related to prior accident
years totaling $11.1 million primarily in the standard property and casualty
program. This adverse development was due primarily to an increase in losses
in the workers compensation and other liability lines of business in the
1998-2001 accident years. A reduction in losses for the 2002 accident year
partially offset this adverse development. The adverse loss development
included approximately $1.3 million for provisions for potentially
uncollectible reinsurance and deductibles.
NAICO does not ordinarily insure against environmental matters as that
term is commonly used. However, in some cases, regulatory filings made by
NAICO on behalf of an insured can make NAICO directly liable to the regulatory
authority for property damage which could include environmental pollution. In
those cases, NAICO ordinarily has recourse against the insured or the surety
bond principal for amounts paid. NAICO has insured certain trucking companies
and pest control operators that are required to provide proof of insurance
which in some cases assures payment for clean-up and remediation of damage
resulting from sudden and accidental release or discharge of contaminants or
other substances which may be classified as pollutants. NAICO also provides
surety bonds for construction contractors that use or have control of such
substances and for contractors that remove and dispose of asbestos as a part of
their contractual obligations. NAICO also insures independent oil and gas
producers that may purchase coverage for the escape of oil, saltwater, or other
substances which may be harmful to persons or property, but may not generally
be classified as pollutants. NAICO maintains claims records which segregate
this type of risk for the purpose of evaluating environmental risk exposure.
Based upon the nature of such lines of business with insureds of NAICO, and
current data regarding the limited severity and infrequency of such matters, it
appears that potential environmental risks are not a significant portion of
claims reserves and therefore would not likely have a material impact, if any,
on the consolidated financial condition, results of operations or cash flows of
Chandler USA.
At this time, NAICO has not received any claims related to the September
11, 2001 terrorist attacks on the World Trade Center and does not believe that
it has any significant exposure to these and related losses. While several of
NAICO's reinsurers did experience significant losses related to these attacks,
it currently does not appear that these losses will impair the reinsurers'
ability to pay claims.
PAGE F-15
NOTE 4. DISCONTINUED OPERATIONS
On December 20, 2002, Chandler USA completed the sale of its wholly owned
subsidiary L&W to Brown & Brown, Inc. for $3,247,000 in cash and a $361,000
note receivable that was paid in December 2003. Chandler USA recorded an
after-tax gain of $671,000 on the sale in 2002 based on the minimum purchase
price for the transaction, after deducting Chandler USA's goodwill related to
L&W of $2,350,000, equity in L&W of $224,000 and approximately $400,000 of
expenses in connection with the sale. The gain on the sale may be increased
over the next three years depending on certain adjustments to the purchase
price as defined in the terms of the transaction, with a maximum purchase price
of $6.0 million. The transaction was effective December 1, 2002.
L&W continues to be a significant producer of business for NAICO. Retail
business produced by L&W and placed with NAICO constituted approximately 9% of
NAICO's direct premiums written and assumed in 2003. Chandler USA maintains
certain wholesale operations related to NAICO's school districts and trucking
insurance through its wholly owned subsidiary, Chandler Insurance Managers,
Inc. ("CIMI"), an underwriting manager that was established in December 2002.
L&W previously functioned as Chandler USA's agency segment and is presented as
discontinued operations.
Chandler USA agreed to indemnify Brown & Brown, Inc. for any breach of a
representation, warranty or covenant made in connection with the sale for a
period of three years, and has deposited cash in the amount of $500,000 into a
trust account for the benefit of Brown & Brown, Inc. as security. Prior to
completing the sale, L&W transferred its real estate to NAICO, and transferred
substantially all of its remaining assets and liabilities, primarily premiums
receivable and premiums payable, to Chandler USA through a shareholder
dividend. Following the completion of the sale, L&W changed its name to Brown
& Brown of Central Oklahoma, Inc.
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. During 2003, Chandler USA purchased and
cancelled $16.7 million principal amount of the Debentures, and at December 31,
2003, there were $7,254,000 principal amount of the Debentures outstanding. As
of December 31, 2003, Chandler USA has capitalized $359,000 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 statement 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, 2003, 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"). Trust I is a Delaware statutory business trust and is a wholly owned
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. Distributions on the Trust I
Preferred Securities are payable quarterly at a fixed annual rate of 9.75%
beginning August 23, 2003. 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.
Trust I used the proceeds from the sale of the Trust I Preferred
Securities to purchase 9.75% junior subordinated debentures (the "Junior
Debentures I") of Chandler USA in like amount, and will distribute any cash
payments it receives thereon to the holders of its preferred and common
securities. The Junior Debentures I are the sole assets of Trust I.
Distributions on the Junior Debentures I are payable quarterly at a fixed
annual rate of 9.75% beginning August 23, 2003. 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 F-16
In December 2003, Chandler USA established Chandler Capital Trust II
("Trust II"). Trust II is a Delaware statutory business trust and is a wholly
owned consolidated subsidiary of Chandler USA. On December 16, 2003, Trust II
issued $7.0 million of capital securities ("Trust II Preferred Securities") to
InCapS Funding II, Ltd., an unaffiliated company established under the laws of
the Cayman Islands, in a private transaction. Distributions on the Trust II
Preferred Securities are payable quarterly at a floating rate of 4.10% over
LIBOR (LIBOR is recalculated quarterly and the interest rate may not exceed
12.5% prior to January 8, 2009) beginning April 8, 2004. The interest rate for
the initial quarterly period was determined to be 5.26813%. 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 II used the proceeds from the sale of the Trust II Preferred
Securities to purchase floating rate junior subordinated debentures (the
"Junior Debentures II") of Chandler USA in like amount, and will distribute any
cash payments it receives thereon to the holders of its preferred and common
securities. The Junior Debentures II are the sole assets of Trust II.
Distributions on the Junior Debentures II are payable quarterly at a floating
rate of 4.10% over LIBOR (LIBOR is recalculated quarterly and the interest rate
may not exceed 12.5% prior to January 8, 2009) beginning April 8, 2004. The
interest rate for the initial quarterly period was determined to be 5.26813%.
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 sale of the Trust I Preferred Securities and the Trust II Preferred
Securities issued by Trust I and Trust II resulted in net proceeds of $19.3
million to Chandler USA, net of placement costs. Issuance costs in the amount
of $711,000 have been capitalized and will be amortized over the stated
maturity period of thirty years. Chandler USA used $13.3 million of the
proceeds to purchase $16.7 million principal amount of its outstanding
Debentures. The Debentures purchased by Chandler USA were cancelled. The
purchase and cancellation of the Debentures resulted in a pre-tax gain of $3.1
million, net of an adjustment to unamortized issuance costs, which is included
in other income in the consolidated statement of operations. Chandler USA also
contributed $5.0 million of the proceeds to NAICO to be used for general
corporate purposes. The Junior Debentures I and Junior Debentures II and
related interest expense are eliminated in Chandler USA's consolidated
financial statements.
NOTE 7. SHAREHOLDER'S EQUITY
CAPITAL STOCK
In addition to the regulatory oversight of NAICO by the Oklahoma
Department of Insurance, Chandler Insurance 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 (loss) and statutory capital and surplus of NAICO are as follows:
2001 2002 2003
-------- -------- --------
(In thousands)
Statutory net income (loss) ........ $ 3,472 $ (405) $ 1,447
Statutory capital and surplus ...... $49,060 $44,073 $50,154
Prior to 2002, the Oklahoma Insurance Code considered office equipment,
furniture and other such property constituting less than 3% of otherwise
admitted assets to be admissible. This prescribed accounting practice
increased NAICO's statutory capital and surplus by $1.1 million at December
31, 2001. During 2002, the Oklahoma Insurance Code was modified to exclude
office equipment, furniture and other such property from admitted assets and
these have been deducted from NAICO's statutory capital and surplus as of
December 31, 2002. There is no difference between NAICO's statutory net income
under Codification and practices prescribed by the Oklahoma Insurance Code.
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.
PAGE F-17
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, 2002 and 2003.
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 2004 without the
approval of the Oklahoma Department of Insurance is approximately $5.0 million.
NAICO paid cash shareholder dividends totaling $7.0 million and $3.5 million to
Chandler USA in 2001 and 2002, respectively. The Oklahoma Department of
Insurance approved the payment of the extraordinary dividend by NAICO to
Chandler USA in 2001.
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 $12.5 million
as of December 31, 2003). NAICO paid approximately $183,000, $120,000 and
$146,000 in policyholder dividends during 2001, 2002 and 2003, respectively.
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:
2001 2002 2003
---------- ---------- ----------
CONTINUING OPERATIONS: (In thousands)
Computed income tax provision (benefit) at 34% ...... $ (158) $ (1,607) $ 736
Increase (decrease) in income taxes resulting from:
Amortization of licenses and other intangibles ... 51 - -
Interest income on tax exempt securities ......... (56) - -
Utilization of capital loss ...................... - (270) (800)
Nondeductible expenses ........................... 179 197 256
---------- ---------- ----------
Federal income tax provision (benefit) .............. $ 16 $ (1,680) $ 192
========== ========== ==========
DISCONTINUED OPERATIONS:
Computed income tax provision (benefit) at 34% ...... $ (211) $ 149 $ -
Increase in income taxes resulting from:
Amortization of goodwill ......................... 208 - -
Other, net ....................................... 5 6 -
---------- ---------- ----------
Federal income tax provision ........................ $ 2 $ 155 $ -
========== ========== ==========
The sale of L&W resulted in a capital loss for tax purposes as Chandler
USA's tax basis in L&W exceeded the consideration received from the sale.
Accordingly, the gain on the sale of $671,000 that was recorded in the
consolidated statement of operations in 2002 was not reduced for income taxes.
PAGE F-18
U.S. Federal income tax provision (benefit) from continuing operations
consists of:
CURRENT DEFERRED TOTAL
--------------- --------------- --------------
(In thousands)
2001 .......................................... $ (1,006) $ 1,022 $ 16
2002 .......................................... (2,033) 353 (1,680)
2003 .......................................... (904) 1,096 192
Deferred income tax provision from continuing operations relating to
temporary differences includes the following components:
2001 2002 2003
--------------- -------------- --------------
(In thousands)
Loss reserve discounts ......................... $ 754 $ 152 $ 276
Unearned premiums .............................. 256 (6) 249
Deferred policy acquisition costs .............. (151) 276 (65)
Reserve for uncollectible premiums receivable .. 161 (58) 38
Depreciation and lease expense ................. (52) 126 627
Discount on fixed maturity investments ......... 9 11 (218)
Other .......................................... 45 (148) 189
--------------- -------------- --------------
$ 1,022 $ 353 $ 1,096
=============== ============== ==============
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:
2002 2003
-------------- --------------
(In thousands)
Deferred tax assets:
Loss reserve discounts ....................................... $ 2,050 $ 1,774
Unearned premiums ............................................ 1,867 1,617
Reserve for uncollectible premiums receivable ................ 84 45
Compensated absences ......................................... 195 231
Net operating loss carryforwards - federal ................... 1,887 1,673
Net operating loss carryforwards - state ..................... 2,987 3,037
Net capital loss carryforward ................................ 1,399 625
Other ........................................................ 125 110
Valuation allowance .......................................... (4,386) (3,662)
-------------- --------------
Total deferred tax assets ....................................... 6,208 5,450
-------------- --------------
Deferred tax liabilities:
Depreciation and lease expense ............................... 842 1,470
Amortization of discount on fixed maturity investments ....... 222 5
Unrealized gain on investments available for sale ............ 891 306
Deferred policy acquisition costs ............................ 121 56
Other ........................................................ 132 124
-------------- --------------
Total deferred tax liabilities .................................. 2,208 1,961
-------------- --------------
Net deferred tax assets ......................................... $ 4,000 $ 3,489
============== ==============
At December 31, 2003, Chandler USA had a net operating loss carryforward
available for U.S. Federal income taxes of $4.9 million which expires in 2023.
In addition, Chandler USA, at December 31, 2003, had net operating loss
carryforwards available for Oklahoma state income taxes totaling approximately
$50.6 million which expire in the years 2004 through 2023. At December 31,
2003, Chandler USA had a capital loss carryforward for U.S. Federal income
taxes of $1.8 million which expires in 2007. A valuation allowance has been
provided for the tax effect of the state net operating loss and net capital
loss carryforwards since realization of such amounts is not considered more
likely than not.
PAGE F-19
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 $4,600 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 from continuing operations was $272,000,
$282,000 and $286,000 for 2001, 2002 and 2003, respectively.
NOTE 10. FAIR VALUE DISCLOSURES OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial
instruments is made in accordance with the requirements of SFAS 107,
DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS. The estimated fair
value amounts have been determined by Chandler USA, using available market
information and appropriate valuation methodologies. However, considerable
judgment is necessarily required in interpreting market data to develop the
estimates of fair value. Accordingly, the estimates of fair values presented
herein are not necessarily indicative of the amounts that Chandler USA could
realize in a current market exchange. The use of different market assumptions
and/or estimation methodologies may have a material effect on the estimated
fair value amounts.
A number of Chandler USA's significant assets (including deferred policy
acquisition costs, property and equipment, reinsurance recoverables, prepaid
reinsurance premiums and state insurance licenses) and liabilities (including
unpaid losses and loss adjustment expenses and unearned premiums) are not
considered financial instruments. Based on the short term nature or other
relevant characteristics, Chandler USA has concluded that the carrying value of
other assets and liabilities considered financial instruments, such as cash
equivalents, premiums receivable, policyholder deposits, accrued taxes and
other payables, and premiums payable, approximates their fair value as of
December 31, 2002 and 2003. The estimated fair values of Chandler USA's
fixed-maturity and equity security investments are disclosed at Note 2. At
December 31, 2003, the fair value of Chandler USA's Debentures was estimated to
be $5.9 million based on recent purchases of the Debentures by Chandler USA.
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 $13.0 million principal amount of trust preferred
securities that mature in 2033 with a fixed interest rate of 9.75%, and $7.0
million principal amount of trust preferred securities that mature in 2034 with
a floating rate of 4.10% over LIBOR, currently 5.26813%. At December 31, 2003,
the fair value of Chandler USA's trust preferred securities was estimated to be
$20.0 million.
NOTE 11. LITIGATION
Certain officers and directors of Chandler USA and Chandler Insurance were
named as defendants in certain litigation involving CenTra, Inc. This
litigation was concluded in 2002. In accordance with its Articles of
Association, Chandler Insurance and its subsidiaries have advanced the
litigation expenses of these persons in exchange for undertakings to repay such
expenses if those persons are later determined to have breached the standard of
conduct provided in the Articles of Association. These expenses together with
certain other expenses may be recovered from Chandler Insurance's director and
officer liability insurance policy (the "D&O Insurer"). As a result of various
events in 1995, 1996 and 1997, Chandler Barbados and Chandler USA recorded
estimated recoveries of costs from its D&O Insurer totaling $3,456,000 and
$1,044,000, respectively, for reimbursable amounts previously paid that relate
to allowable defense and litigation costs for such parties. Chandler Barbados
and Chandler USA received payment for a 1995 claim during 1996 in the amount of
$636,000 and $159,000, respectively. The balance of $2,820,000 and $885,000 is
included in other assets in Chandler Insurance's and Chandler USA's respective
balance sheets. Chandler Insurance assumed this receivable from Chandler
Barbados during December 2003 under the reorganization of these companies.
Chandler Insurance and its subsidiaries contend they are entitled to a total of
$5 million under the applicable insurance policy to the extent they have
advanced reimbursable expenses. The D&O Insurer contends that certain policy
provisions exclude coverage for these claims. On August 22, 2001, Chandler
Insurance and its subsidiaries, including Chandler USA, filed an action in the
State District Court in Oklahoma City, Oklahoma ("Oklahoma State Court")
alleging that the director and officer liability insurance policies should be
rescinded and seeking repayment of more than $5 million in premiums they
previously paid. Chandler Insurance and its subsidiaries are currently
involved in litigation with the insurer for payment of the policy balance or
rescission and repayment of premiums previously paid. The litigation is
pending in the Oklahoma State Court. The case is still in the early pleading
stages and Chandler USA cannot predict the date of resolution or the outcome of
this case. Chandler Insurance and its subsidiaries may or may not recover the
remaining policy limits or the previously paid premiums and could incur
significant costs in resolving this matter.
PAGE F-20
Transamerica Occidental Life Insurance Company ("Transamerica") reinsured
NAICO for certain workers compensation risks during 1989, 1990 and 1991.
Beginning in 1996, Transamerica refused to pay NAICO for balances that it owed
under the reinsurance treaties. Transamerica owes NAICO approximately $1.6
million for reinsurance recoverables on paid losses and loss adjustment
expenses as of December 31, 2003. NAICO is currently engaged in arbitration
in order to enforce the terms of the reinsurance treaties.
Chandler USA and its subsidiaries are not parties to any other 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.
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.
Treaty reinsurance may be ceded under treaties on both a pro rata or
proportional 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. A majority of
NAICO's reinsurance programs renew on January 1 or July 1 of each year. NAICO
renewed all January 1, 2004 reinsurance programs. At the present time, NAICO
expects to renew the reinsurance programs that renew on July 1, 2004.
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.
Reliance Insurance Company ("Reliance") reinsured NAICO for certain
workers compensation risks during 1998. At December 31, 2003, NAICO had
reinsurance recoverables from Reliance for paid and unpaid losses of
approximately $3.1 million. During October 2001, the Commonwealth of
Pennsylvania placed Reliance in liquidation. At this time, NAICO is unable to
determine the amount of its reinsurance recoverables from Reliance that will
ultimately be collected and has fully reserved the carrying value of such
amounts as of December 31, 2003.
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 2001,
2002 and 2003, NAICO incurred charges of $454,000, $1.7 million and $604,000,
respectively, in adjustments to ceded losses and loss adjustment expenses for
amounts deemed uncollectible.
PAGE F-21
The effect of reinsurance on premiums written and earned was as follows:
2001 2002 2003
----------------------- ----------------------- -----------------------
WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED
----------- ---------- ----------- ---------- ----------- ----------
(In thousands)
Direct ............... $ 158,741 $ 171,378 $ 139,876 $ 146,307 $ 118,247 $ 126,067
Assumed .............. 223 223 286 256 197 212
Ceded ................ (93,541) (101,616) (72,495) (79,606) (66,604) (69,696)
----------- ---------- ----------- ---------- ----------- ----------
Net premiums ......... $ 65,423 $ 69,985 $ 67,667 $ 66,957 $ 51,840 $ 56,583
=========== ========== =========== ========== =========== ==========
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 $99.9 million,
$87.7 million and $83.9 million for 2001, 2002 and 2003, respectively.
SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK
NAICO conducts its business through individual independent insurance
agencies and underwriting managers. Certain of these underwriting managers
have provided collateral to NAICO to secure a portion of the premiums
receivable. Substantially all of the principal shareholders of the independent
agencies and underwriting managers have provided personal guarantees for
payment of premiums to NAICO. NAICO also 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, 2002 and 2003 were $24.0
million and $20.3 million, respectively. Receivables for deductibles, in most
cases, are secured by cash deposits and letters of credit. At December 31,
2003, NAICO maintained custody of such letters of credit securing these and
other transactions totaling approximately $15.4 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 2001, 2002 or 2003.
NAICO's bail bond underwriting manager was responsible for gross written
premiums of $2.3 million, $2.3 million and $1.2 million during 2001, 2002 and
2003, respectively.
Approximately $25.7 million, or 28% of NAICO's reinsurance recoverables
and prepaid reinsurance premiums at December 31, 2003 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.
PAGE F-22
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, 2003.
CEDED REINSURANCE
NET PREMIUMS FOR A.M. BEST
REINSURANCE THE YEAR ENDED COMPANY
NAME OF REINSURER RECOVERABLE (1) DECEMBER 31, 2003 RATING
- ---------------------------------------------------------- --------------- ------------------- ---------
(Dollars in thousands)
Swiss Reinsurance America Corporation .................... $ 28,649 $ 130 A+
Chandler Insurance ....................................... 19,529 25,992 -(2)
Employers Reinsurance Corporation ........................ 18,385 18,907 A
Red River Reinsurance, Ltd. .............................. 5,904 5,016 -(3)
GE Reinsurance Corporation ............................... 5,109 (113) A
--------------- -------------------
Top five reinsurers ................................. $ 77,576 $ 49,932
=============== ===================
All reinsurers ...................................... $ 92,522 $ 66,604
=============== ===================
Percentage of total represented by top five reinsurers ... 84% 75%
- ----------------------------------------------------------
(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, 2003.
(2) Chandler Insurance owns 100% of the common stock of Chandler USA, which in turn owns 100% of the common
stock of NAICO. 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, 2003, Chandler Insurance had cash and investments with a fair value of
$19.7 million deposited in a trust account for the benefit of NAICO. Chandler Insurance includes amounts
assumed from Chandler Barbados that resulted from the transfer of its business to Chandler Insurance in
December 2003.
(3) Red River Reinsurance, Ltd. ("Red River") is required to secure its reinsurance obligations by depositing
acceptable securities in trust for NAICO's benefit. At December 31, 2003, Red River's reinsurance recoverables
were collateralized by cash and investments with a fair value of $6.2 million deposited in a trust account for
the benefit of NAICO and by premiums payable to Red River of approximately $730,000.
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.
Chandler USA had an employment agreement with Brenda B. Watson, an
executive officer of NAICO and L&W. Under this agreement, Ms. Watson's base
compensation was established at not less than $125,000 per year. The agreement
terminated on December 31, 2003. In addition to her base compensation, Ms.
Watson 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.
PAGE F-23
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 was
approximately $1,049,000 and $853,000 at December 31, 2002 and 2003,
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 in the amount that it expects to recover of
approximately $1,808,000 and $2,451,000 at December 31, 2002 and 2003,
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 of such assessments.
At December 31, 2003, Chandler USA's subsidiaries were committed under
noncancellable operating leases for certain equipment and office space. Rental
payments under these leases for continuing operations were $1,084,000,
$1,086,000 and $919,000 in 2001, 2002 and 2003, respectively. Future minimum
lease payments are as follows:
(In thousands)
2004 .......................... $ 441
2005 .......................... 172
2006 .......................... 46
2007 .......................... 11
2008 .......................... 11
--------------
$ 681
==============
During March 2001, Chandler USA entered into a $3.8 million sale and
leaseback transaction for certain owned equipment. Chandler USA agreed to
lease the equipment for three years with monthly rental installments equal to
the sum of (i) $22,167 plus (ii) interest on the unpaid lease balance at a
floating interest rate of 1% over Chase Manhattan Bank Prime, which was 4.0%
at December 31, 2003. The sale and leaseback transaction resulted in a
reduction of property and equipment of $1.9 million and a deferred gain of
$2.0 million which is included in accrued taxes and other payables. During
2003, Chandler USA exercised its option to repurchase the equipment at the end
of the lease for approximately $3.0 million. The deferred gain is being
amortized into income over the final year of the lease, resulting in other
income of $1.7 million in 2003.
Chandler USA has guaranteed the obligations of Trust I and Trust II. It
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
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 $263,000, $255,000 and $336,000 in expenses associated with this
property during 2001, 2002 and 2003, respectively, including $25,000, $18,000
and $12,000 for reimbursement of certain expenses, such as utility and similar
expenses, for the years 2001, 2002 and 2003, 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, 2002
and 2003, Chandler USA had a receivable of $10.6 million and $9.6 million,
respectively, under the Credit Agreement, and Chandler USA earned $371,000,
$380,000 and $412,000 in interest income under the Credit Agreement during
2001, 2002 and 2003, respectively.
PAGE F-24
NOTE 14. SEGMENT INFORMATION
Chandler USA has one reportable operating segment for property and
casualty insurance. In December 2002, Chandler USA sold L&W, which had
previously been reported as Chandler USA's agency segment. The agency segment
and certain items related to L&W have been restated and reported as
discontinued operations for all periods presented.
The insurance products reported in the property and casualty segment are
underwritten by NAICO and are marketed through independent insurance agencies.
NAICO underwrites various lines of property and casualty insurance, including
surety bonds and workers compensation insurance. NAICO's main areas of
concentration include the construction, manufacturing, oil and gas, wholesale,
service and retail industries along with political subdivisions. The property
and casualty segment operates primarily in Oklahoma and Texas, and other
surrounding states. Oklahoma accounted for approximately 49%, 53% and 51% of
gross written premiums in 2001, 2002 and 2003, respectively, while Texas
accounted for approximately 41%, 37% and 36% of gross written premiums during
the same years. Management evaluates the property and casualty segment's
performance on the basis of growth in gross written premiums 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.
Net premiums earned and losses and loss adjustment expenses within the
property and casualty segment can be identified to Chandler USA designated
insurance programs. Chandler USA's chief operating decision makers review net
premiums earned and losses and loss adjustment expenses in assessing the
performance of an insurance program. In addition, Chandler USA's chief
operating decision makers consider many other factors such as the lines of
business offered within an insurance program and the states in which the
insurance programs are offered. Certain discrete financial information is not
readily available by insurance program, including assets, interest income, and
investment gains or losses, allocated to each insurance program. Chandler USA
does not consider its insurance programs to be reportable segments, however,
the following supplemental information pertaining to each insurance program's
net premiums earned and losses and loss adjustment expenses is presented for
the property and casualty segment.
YEAR ENDED DECEMBER 31,
--------------------------------
INSURANCE PROGRAM 2001 2002 2003
- ---------------------------------------------------- ---------- ---------- ----------
(In thousands)
NET PREMIUMS EARNED
Standard property and casualty ..................... $ 53,130 $ 49,570 $ 45,521
Political subdivisions ............................. 12,534 13,829 8,093
Surety bonds ....................................... 4,125 3,310 2,724
Other (1) .......................................... 196 248 245
---------- ---------- ----------
$ 69,985 $ 66,957 $ 56,583
========== ========== ==========
LOSSES AND LOSS ADJUSTMENT EXPENSES
Standard property and casualty ..................... $ 37,707 $ 40,194 $ 29,650
Political subdivisions ............................. 11,420 7,726 5,722
Surety bonds ....................................... 2,339 1,967 911
Other (1) .......................................... 1,084 825 917
---------- ---------- ----------
$ 52,550 $ 50,712 $ 37,200
========== ========== ==========
- --------------------------------------
(1) This category is comprised primarily of the run-off of discontinued programs and NAICO's
participation in various mandatory workers compensation pools and assigned risks.
PAGE F-25
NOTE 15. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
A summary of the unaudited quarterly operating results during 2002 and
2003 follows:
First Second Third Fourth Total
quarter quarter quarter quarter year
--------- --------- --------- --------- ---------
2002
- --------------------------------------------
Net premiums earned ........................ $ 16,225 $ 17,126 $ 16,972 $ 16,634 $ 66,957
Interest income, net ....................... 695 798 665 762 2,920
Realized investment gains, net ............. 16 388 - 390 794
Income (loss) before income taxes .......... (136) 1,203 (71) (5,722) (4,726)
Income (loss) from continuing operations ... (157) 761 (82) (3,568) (3,046)
Income (loss) from discontinued operations.. 41 198 56 (11) 284
Gain on sale of subsidiary ................. - - - 671 671
Net income (loss) .......................... (116) 959 (26) (2,908) (2,091)
2003
- --------------------------------------------
Net premiums earned ........................ $ 14,537 $ 14,421 $ 14,145 $ 13,480 $ 56,583
Interest income, net ....................... 596 662 625 677 2,560
Realized investment gains, net ............. 151 1,787 413 - 2,351
Income (loss) before income taxes .......... (311) 3,389 470 (1,382) 2,166
Income (loss) from continuing operations ... (223) 2,791 398 (992) 1,974
Income (loss) from discontinued operations.. - - - - -
Net income (loss) .......................... (223) 2,791 398 (992) 1,974
During the second quarter of 2003, realized investment gains included a
gain of $1.7 million from the sale of 19,371 shares of common stock of
Insurance Services Office, Inc. ("ISO"). NAICO received these shares in 1997
as a result of ISO converting to a for-profit corporation. Chandler USA
recorded other income of $2.2 million and $879,000 in the second quarter and
fourth quarter of 2003, respectively, related to the purchase and cancellation
of Debentures.
* * * * * * *
PAGE F-26
INDEPENDENT AUDITORS' REPORT
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, 2002
and 2003, 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, 2003. Our audit also included the financial
statement schedules listed in the Index at Item 15. 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.
We conducted our audits in accordance with the auditing standards generally
accepted in the United States of America. 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 at
December 31, 2002 and 2003, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 2003 in
conformity with accounting principles generally accepted in the United States
of America. Also, in our opinion, such financial statement schedules, when
considered in relation to the basic consolidated financial statements taken as
a whole, present fairly, in all material respects, the information set forth
therein.
/s/ Tullius Taylor Sartain & Sartain LLP
TULLIUS TAYLOR SARTAIN & SARTAIN LLP
Tulsa, Oklahoma
February 26, 2004
PAGE F-27
SCHEDULE I
CHANDLER (U.S.A.), INC. AND SUBSIDIARIES
SUMMARY OF INVESTMENTS - OTHER
THAN INVESTMENTS IN RELATED PARTIES
AS OF DECEMBER 31, 2003
(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 ......... $ 38,565 $ 39,011 $ 39,011
Corporate obligations ........................... 11,645 11,868 11,868
Public utilities ................................ 6,816 7,016 7,016
Mortgage-backed securities ...................... 4,145 4,085 4,085
------------ ------------ ---------------
61,171 61,980 61,980
Equity securities available for sale:
Corporate stock ................................. - 92 92
------------ ------------ ---------------
Total investments ............................ $ 61,171 $ 62,072 $ 62,072
============ ============ ===============
SEE INDEPENDENT AUDITORS' REPORT.
PAGE F-28
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,
---------------------
2002 2003
---------- ----------
ASSETS
Cash ............................................................ $ 2,355 $ 495
Premiums receivable ............................................. 979 9
Amounts due from subsidiaries ................................... 1,762 1,437
Property and equipment, net ..................................... 825 1,057
Amounts due from related parties ................................ 10,582 9,642
Other assets .................................................... 4,870 3,610
Investment in subsidiaries, net ................................. 52,036 57,536
---------- ----------
Total assets .................................................... $ 73,409 $ 73,786
========== ==========
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Accrued taxes and other payables ............................. $ 4,081 $ 2,073
Premiums payable ............................................. 2,328 -
Debentures ................................................... 24,000 27,874
---------- ----------
Total liabilities ............................................... 30,409 29,947
---------- ----------
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 .......................................... (19,316) (17,342)
Accumulated other comprehensive income:
Unrealized gain on investments held by subsidiary and available
for sale, net of deferred income taxes .................... 1,730 595
---------- ----------
Total shareholder's equity ...................................... 43,000 43,839
---------- ----------
Total liabilities and shareholder's equity ...................... $ 73,409 $ 73,786
========== ==========
SEE INDEPENDENT AUDITORS' REPORT.
PAGE F-29
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,
--------------------------------
2001 2002 2003
---------- ---------- ----------
Revenues
Interest income, net ............................................. $ 8 $ 7 $ 34
Interest income, net from related parties ........................ 371 380 436
Other income ..................................................... 618 765 5,600
---------- ---------- ----------
Total revenues ................................................ 997 1,152 6,070
---------- ---------- ----------
Operating costs and expenses
General and administrative expenses .............................. 2,442 3,529 3,175
Interest expense ................................................. 2,213 2,213 2,447
---------- ---------- ----------
Total operating costs and expenses ............................ 4,655 5,742 5,622
---------- ---------- ----------
Income (loss) from continuing operations before income tax benefit .. (3,658) (4,590) 448
Federal income tax benefit .......................................... 1,143 1,729 509
---------- ---------- ----------
Net income (loss) from continuing operations before equity
in net income (loss) of subsidiaries ............................. (2,515) (2,861) 957
Equity in net income of subsidiaries ................................ 2,025 133 1,017
---------- ---------- ----------
Net income (loss) from continuing operations ........................ (490) (2,728) 1,974
Loss from discontinued operations ................................... (613) (34) -
Gain on sale of subsidiary .......................................... - 671 -
---------- ---------- ----------
Net income (loss) ................................................... $ (1,103) $ (2,091) $ 1,974
========== ========== ==========
SEE INDEPENDENT AUDITORS' REPORT.
PAGE F-30
SCHEDULE II
CHANDLER (U.S.A.), INC. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CHANDLER (U.S.A.), INC.
(PARENT COMPANY ONLY)
STATEMENTS OF CASH FLOWS
(In thousands)
YEAR ENDED DECEMBER 31,
--------------------------------
2001 2002 2003
---------- ---------- ----------
OPERATING ACTIVITIES
Net income (loss) ............................................ $ (1,103) $ (2,091) $ 1,974
Add (deduct):
Adjustments to reconcile net income (loss) to cash
applied to operating activities:
Net income of subsidiaries not distributed to parent ...... (2,025) (133) (1,017)
Net (gains) losses on sale of property and equipment ...... 2 (12) (1,661)
Gain on sale of subsidiary ................................ - (671) -
Gain on retirement of debentures .......................... - - (3,106)
Amortization and depreciation ............................. 834 222 221
Net change in non-cash balances relating to
operating activities:
Premiums receivable .................................... - 2,778 970
Amounts due from subsidiaries .......................... 264 314 325
Other assets ........................................... 1,121 1,428 1,020
Accrued taxes and other payables ....................... (729) (692) (334)
Premiums payable ....................................... - (3,200) (2,328)
---------- ---------- ----------
Cash applied to operating activities ...................... (1,636) (2,057) (3,936)
---------- ---------- ----------
Investing activities
Cost of property and equipment purchased ..................... (682) (103) (471)
Proceeds from sale of property and equipment ................. 3,915 57 100
Proceeds from sale of subsidiary ............................. - 3,247 -
Investment in subsidiary ..................................... - (2) (5,620)
---------- ---------- ----------
Cash provided by (applied to) investing activities ........ 3,233 3,199 (5,991)
---------- ---------- ----------
Financing activities
Shareholder dividend from subsidiaries ....................... 7,000 3,915 -
Proceeds from issuance of debentures ......................... - - 20,620
Payment on retirement of debentures .......................... - - (12,782)
Debt issue costs ............................................. - - (711)
Payments and loans from related parties ...................... 4,032 3,249 2,426
Payments and loans to related parties ........................ (12,629) (5,951) (1,486)
---------- ---------- ----------
Cash provided by (applied to) financing activities ........ (1,597) 1,213 8,067
---------- ---------- ----------
Increase (decrease) in cash and cash equivalents ................ - 2,355 (1,860)
Cash and cash equivalents at beginning of year .................. - - 2,355
---------- ---------- ----------
Cash and cash equivalents at end of year ........................ $ - $ 2,355 $ 495
========== ========== ==========
SEE INDEPENDENT AUDITORS' REPORT.
PAGE F-31
SCHEDULE III
CHANDLER (U.S.A.), INC. AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
(In thousands)
FUTURE
POLICY AMORTI-
BENEFITS, OTHER ZATION OF NET
DEFERRED LOSSES, POLICY CLAIMS, DEFERRED PREMIUMS
POLICY CLAIMS CLAIMS AND NET LOSSES 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
----------- -------- -------- ---------- --------- --------- ---------- ----------- --------- --------
YEAR ENDED
DECEMBER 31, 2001
Property and casualty .. $ (456) $ 84,756 $ 61,562 $ 4,600 $ 69,985 $ 4,003 $ 52,550 $ 10,869 $ 13,789 $ 65,423
========== ======== ======== ========== ========= ========= ========== =========== ========= ========
DECEMBER 31, 2002
Property and casualty .. $ 355 $ 92,606 $ 55,160 $ 4,244 $ 66,957 $ 2,920 $ 50,712 $ 10,239 $ 14,707 $ 67,667
========== ======== ======== ========== ========= ========= ========== =========== ========= ========
DECEMBER 31, 2003
Property and casualty .. $ 165 $ 87,768 $ 47,325 $ 4,807 $ 56,583 $ 2,560 $ 37,200 $ 11,278 $ 15,927 $ 51,840
========== ======== ======== ========== ========= ========= ========== =========== ========= ========
SEE INDEPENDENT AUDITORS' REPORT.
PAGE F-32
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, 2001
Property and casualty ........................... $ 158,741 $ (93,541) $ 223 $ 65,423 0.34 %
============ ============ ============ ============ ============
Year ended December 31, 2002
Property and casualty ........................... $ 139,876 $ (72,495) $ 286 $ 67,667 0.42 %
============ ============ ============ ============ ============
Year ended December 31, 2003
Property and casualty ........................... $ 118,247 $ (66,604) $ 197 $ 51,840 0.38 %
============ ============ ============ ============ ============
SEE INDEPENDENT AUDITORS' REPORT.
PAGE F-33
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:
2001 ............................................ $ 308 $ 305 $ (315) $ 298
================ ================ ================ ===============
2002 ............................................ $ 298 $ 444 $ (496) $ 246
================ ================ ================ ===============
2003 ............................................ $ 246 $ 272 $ (385) $ 133
================ ================ ================ ===============
Allowance for non-collection of reinsurance
recoverables on paid and unpaid losses:
2001 ............................................ $ 672 $ 454 $ (30) $ 1,096
================ ================ ================ ===============
2002 ............................................ $ 1,096 $ 1,726 $ (55) $ 2,767
================ ================ ================ ===============
2003 ............................................ $ 2,767 $ 604 $ (57) $ 3,314
================ ================ ================ ===============
SEE INDEPENDENT AUDITORS' REPORT.
PAGE F-34
SCHEDULE VI
CHANDLER (U.S.A.), INC. AND SUBSIDIARIES
SUPPLEMENTAL INFORMATION
(FOR PROPERTY-CASUALTY INSURANCE UNDERWRITERS)
(In thousands)
DISCOUNT PAID LOSSES AND
DEDUCTED LOSS ADJUSTMENT
FROM RESERVES EXPENSES
--------------- ---------------
Year ended December 31, 2001
Property-casualty ........................................ $ - $ 66,445
=============== ===============
Year ended December 31, 2002
Property-casualty ........................................ $ - $ 50,333
=============== ===============
Year ended December 31, 2003
Property-casualty ........................................ $ - $ 41,048
=============== ===============
SEE INDEPENDENT AUDITORS' REPORT.
PAGE F-35
INDEX TO EXHIBITS
-----------------
EXHIBIT NO.
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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.
10.12 Indenture, dated as of December 16, 2003 among Chandler (U.S.A.),
Inc., as issuer, and Wilmington Trust Company, as trustee.
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.
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 I, Ltd., as purchaser.
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.
14.1 Code of Ethics.
21.1 Subsidiaries of the registrant.
31.1 Rule 13a-14(a)/15d-14(a) Certifications.
32.1 Section 1350 Certifications.