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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, 1999
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) (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
----------------------------------- -----------------------------------------
$24,000,000 8.75% SENIOR DEBENTURES 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
-----
Aggregate market value of the voting stock held by non-affiliates of
the registrant on February 29, 2000: None.
The number of common shares, $1.00 par value, of the registrant
outstanding on February 29, 2000 was 2,484, which are owned by Chandler
Insurance (Barbados), Ltd., a wholly owned subsidiary of 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.
REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION (I)(1)(a)
AND (b) OF FORM 10-K AND IS THEREFORE FILING THIS FORM 10-K WITH THE REDUCED
DISCLOSURE FORMAT.
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<PAGE>
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, oral statements made by Chandler USA's officials to analysts and
shareholders in the course of presentations about Chandler USA and conference
calls following earnings releases, 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 operates;
(iv) claims frequency; (v) claims severity; (vi) the number of new and
renewal policy applications submitted by Chandler USA's agents; (vii) the
ability of National American Insurance Company ("NAICO") to obtain adequate
reinsurance in amounts and at rates that will not adversely affect its
competitive position; (viii) the ability of NAICO to maintain favorable
insurance company ratings; (ix) the ability of Chandler USA and its third
party providers, agents and reinsurers to adequately address year 2000
issues; and (x) other factors including the ongoing litigation matters
involving a significant concentration of ownership of Chandler USA's indirect
parent's common stock.
ITEM 1. BUSINESS
GENERAL
Chandler USA is an insurance holding company that provides
administrative services to its wholly owned subsidiaries NAICO and LaGere
& Walkingstick Insurance Agency, Inc. ("L&W"). Through its subsidiaries,
Chandler USA operates in two lines of business: property and casualty
insurance and insurance agency operations. Chandler USA is an Oklahoma
corporation which is wholly owned by Chandler Insurance (Barbados), Ltd.
("Chandler Barbados"), which, in turn, is wholly owned by Chandler Insurance
Company, Ltd. ("Chandler Insurance"), a Cayman Islands company whose common
stock is traded on The Nasdaq Stock Market under the symbol: CHANF. Chandler
USA is headquartered in Chandler, Oklahoma, in facilities also occupied by
NAICO and L&W.
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
230 at December 31, 1999, 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. Currently, NAICO is rated
as "A- (Excellent)" by A.M. Best Company, an insurance rating agency. NAICO
is also rated "A (Strong)" by Standard & Poor's rating agency. These ratings
are independent opinions of a company's financial strength, operating
performance and ability to meet its obligations to policyholders.
L&W is an independent insurance agency that represents various insurance
companies providing a variety of property and casualty, individual and group
life, medical and disability income coverages. L&W also acts as a surplus
lines broker specializing in risk management and brokering insurance primarily
for commercial enterprises.
Chandler Barbados is a Barbados company and a wholly owned subsidiary of
Chandler Insurance that principally reinsures risks underwritten by NAICO.
NAICO retains a portion of each risk, then transfers the balance to other
reinsurance companies including Chandler Barbados. Chandler Insurance
reinsures Chandler Barbados for a portion of the risk that it assumes from
NAICO.
INSURANCE PROGRAMS
NAICO writes various property and casualty insurance products through
four primary marketing programs. The programs are standard property and
casualty, political subdivisions, surety bonds and group accident and health.
<PAGE>
PAGE 2
STANDARD PROPERTY AND CASUALTY PROGRAM
NAICO offers workers compensation, automobile liability and physical
damage, general 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.
POLITICAL SUBDIVISIONS PROGRAM
Under the political subdivisions program, NAICO writes insurance policies
for school districts, counties and municipalities. As of December 31, 1999,
NAICO insured 526 school districts in Oklahoma and 153 school districts in
Texas. The coverages offered include workers compensation, automobile
liability, automobile physical damage, general liability, property and school
board legal liability.
NAICO also writes property and casualty insurance for municipalities and
counties in Oklahoma, Texas and Missouri. The coverages offered include
workers compensation, automobile and general liability, automobile physical
damage, property and public officials liability insurance. As of December
31, 1999, NAICO insured 270 municipalities and counties in Oklahoma, Texas and
Missouri.
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. Individual bonds generally do not exceed $5 million, and an
individual contractor generally does not have "work in progress" for both
bonded and unbonded jobs in excess of $10 million. A substantial portion of
this business is written in Oklahoma, Texas and California. NAICO also writes
bail bonds, which guarantee that the principal will discharge obligations set
by the court, as well as other types of miscellaneous bonds.
GROUP ACCIDENT AND HEALTH PROGRAM
In 1996, NAICO began offering excess accident and health coverage for
small to medium sized employers that self-insure a portion of their company's
medical plans. In January 1999, NAICO began a new program covering primarily
Oklahoma employers on a fully insured basis. NAICO discontinued writing new
policies for excess accident and health coverage effective April 1, 1999.
NAICO is currently evaluating the fully insured program and may modify or
discontinue the program during 2000.
The following table shows gross premiums earned and net premiums earned
by insurance program for the years 1997, 1998 and 1999. 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.
<TABLE>
<CAPTION>
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
-------------------------------- --------------------------------
INSURANCE PROGRAMS 1997 1998 1999 1997 1998 1999
- ---------------------------------------------- ---------- ---------- ---------- ---------- ---------- ----------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Standard property and casualty................ $ 62,841 $ 76,458 $ 99,512 $ 44,887 $ 29,234 $ 56,673
Political subdivisions........................ 21,503 25,091 29,994 12,416 10,435 14,320
Surety bonds.................................. 12,320 11,915 13,660 10,533 7,456 7,835
Group accident and health..................... 3,379 6,067 9,098 2,303 4,610 8,195
Nonstandard private-passenger automobile (1).. 14,303 6,016 118 8,841 482 4
Other (2)..................................... 2,363 487 65 1,722 207 71
---------- ---------- ---------- ---------- ---------- ----------
TOTAL......................................... $ 116,709 $ 126,034 $ 152,447 $ 80,702 $ 52,424 $ 87,098
========== ========== ========== ========== ========== ==========
- ----------------------------
<FN>
(1) The nonstandard private-passenger automobile program was discontinued in 1997.
(2) This category is comprised primarily of the run-off of other discontinued programs and NAICO's
participation in various mandatory workers compensation pools and assigned risks.
</TABLE>
<PAGE>
PAGE 3
LINES OF INSURANCE
The lines of insurance written by NAICO through its programs are workers
compensation, automobile liability, surety, accident and health, automobile
physical damage, property, inland marine and other liability lines, which
include general and professional liability lines. 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. See "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS."
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------
1995 1996 1997 1998 1999
----------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Workers compensation.................................. 42% 45% 44% 19% 34%
Other liability....................................... 7% 9% 13% 22% 19%
Automobile liability.................................. 21% 21% 17% 22% 17%
Surety................................................ 19% 12% 13% 14% 9%
Accident and health................................... -% 1% 3% 9% 9%
Automobile physical damage............................ 9% 9% 7% 9% 8%
Property.............................................. 2% 2% 2% 4% 3%
Inland marine......................................... -% 1% 1% 1% 1%
----------- ---------- ---------- ---------- ----------
Total............................................ 100% 100% 100% 100% 100%
=========== ========== ========== ========== ==========
</TABLE>
AGENCY AND BROKERAGE
L&W is appointed by insurers to solicit applications for insurance
policies, primarily in Oklahoma. L&W represents various personal and
commercial lines insurance companies in marketing property and casualty
insurance. L&W also markets individual and group life, medical and
disability income coverage. Major target classes of business include
political subdivisions, health care facilities, transportation companies,
manufacturers, contractors, energy businesses, retailers, wholesalers and
service organizations. L&W places a large portion of its property and
casualty business with NAICO. It also acts as a surplus lines broker
specializing in risk management and brokering insurance for commercial
enterprises. L&W places direct agency business as well as business from
other agents with specialty insurance companies.
L&W acts as a broker for NAICO, accepting applications for insurance and
surety bonds from independent agents who, in many instances, are not agents
appointed directly by NAICO. L&W also acts as an underwriter for a
significant portion of NAICO's surety bond program.
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 its bail bond program. During 1997, 1998 and 1999,
the gross written premiums in this program were $2.6 million, $2.8 million and
$2.8 million, respectively. This underwriting manager operates through a
network of bail bond agents who submit applications to the underwriting
manager. If the application meets the specific guidelines set by the
underwriting manager, a bail bond is issued. 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's claim 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.
<PAGE>
PAGE 4
REINSURANCE
In the ordinary course of business, NAICO cedes insurance risks and a
portion of the insurance premiums to its reinsurers under various reinsurance
contracts that cover individual risks (facultative reinsurance) or entire
classes of business (treaty reinsurance). Reinsurance provides greater
diversification of insurance risk associated with business written and also
reduces NAICO's exposure from high policy limits or from catastrophic events
and hazards of an unusual nature. Amounts recoverable from reinsurers are
estimated in a manner consistent with the claim liability associated with the
reinsured policies. In formulating its reinsurance programs, NAICO considers
numerous factors, including the financial stability of the reinsurer, the
reinsurer's ability to provide sufficient collateral (if required),
reinsurance coverage offered and price.
Treaty reinsurance may be ceded under treaties on both a pro rata 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, April 1 or
July 1 of each year. NAICO renewed all January 1, 2000 reinsurance
programs. At the present time, NAICO expects to renew the reinsurance
programs that renew on April 1 or July 1, 2000 as applicable.
NAICO has structured separate reinsurance programs for construction
surety bonds, property (including inland marine), workers compensation,
casualty (including automobile liability, general liability, umbrella
liability and related professional liability), automobile physical damage
and group accident and health. Chandler Barbados reinsures NAICO for a
portion of the risk on NAICO's construction surety bonds, workers
compensation and casualty reinsurance programs. A portion of the risk
that Chandler Barbados assumes from NAICO is reinsured by Chandler Insurance.
Under the 1997 workers compensation reinsurance program, NAICO retained
80% of the first $500,000 of loss per occurrence. During 1998, NAICO's
retention was reduced to 35% of the first $10,000 of loss per occurrence.
During the fourth quarter of 1999, NAICO agreed to rescind reinsurance
treaties which covered 15% of the first $10,000 of loss per occurrence and
75% of $490,000 excess of $10,000 of loss per occurrence for its workers
compensation business and which had been in effect since January 1, 1999.
NAICO received a fee of $10.0 million as compensation for agreeing to
rescind the reinsurance treaties and to assume the additional risk.
Effective January 1, 2000, NAICO's net retention was reduced to 42.5% of the
first $10,000 of loss per occurrence plus 37.5% of $90,000 excess of $10,000
of loss per occurrence.
Under the 1997 casualty reinsurance program, NAICO retained 80% of the
first $500,000 of loss per occurrence. During 1998, NAICO's retention was
reduced to 80% of the first $250,000 of loss per occurrence. Effective
January 1, 2000, NAICO's retention was reduced to 80% of the first $100,000
of loss per occurrence.
Under the 1997 construction surety bond reinsurance program, NAICO
retained 90% of the first $500,000 per bond or per principal (e.g.,
contractor). NAICO's retention was reduced to 50% of the first $500,000 per
bond or per principal, effective January 1, 1998, and was further reduced to
50% of the first $250,000 per bond or per principal effective April 1, 1998.
Under the property reinsurance program, NAICO retains 30% of the first
$500,000 of risk for each loss per location. Under the group accident and
health program, NAICO retains the first $50,000 in excess of the self-insured
retention for each insured person, each policy, and the first $100,000 (or
the first $250,000 for cases exceeding 400 covered employees) of losses in
excess of the self-insured aggregate retention. NAICO retains the first
$100,000 of risk for each insured person for fully insured cases under its
group accident and health program.
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
is purchased primarily from Lloyd's of London. Under its automobile physical
damage reinsurance program, NAICO retains the first $250,000 of loss per
occurrence, plus 5% of amounts exceeding $250,000 of loss per occurrence up
to $1 million of loss per occurrence. NAICO has also purchased reinsurance
which limits its net retained loss for both automobile physical damage and
property losses to $1,000,000 for each loss occurrence. NAICO also purchases
facultative reinsurance when it writes a risk with limits of liability
exceeding the maximum limits of its treaties or when it otherwise considers
such action appropriate.
<PAGE>
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, 1999.
<TABLE>
<CAPTION>
CEDED REINSURANCE
NET PREMIUMS FOR A.M.
REINSURANCE THE YEAR ENDED BEST CO.
NAME OF REINSURER RECOVERABLE (1) DECEMBER 31, 1999 RATING
- ---------------------------------------------------------- ---------------- ------------------- ----------
(Dollars in thousands)
<S> <C> <C> <C>
Chandler Barbados......................................... $ 19,145 $ 23,599 -(3)
First Excess and Reinsurance Corporation.................. 16,528 10,709 A
Swiss Reinsurance America Corporation..................... 10,801 12,909 A+
SCOR Reinsurance Company.................................. 8,544 9,479 A+
Reliance Insurance Company (2)............................ 5,253 (5,484) A-
---------------- -------------------
Top five reinsurers.................................. $ 60,271 $ 51,212
================ ===================
All reinsurers....................................... $ 79,927 $ 65,297
================ ===================
Percentage of total represented by top five reinsurers.... 75% 78%
- ----------------------------------------------------------
<FN>
(1) Includes losses and loss adjustment expenses paid and outstanding, unpaid losses and loss adjustment
expenses and prepaid reinsurance premiums recoverable from reinsurers as of December 31, 1999.
(2) Excludes premiums receivable of $12.9 million as of December 31, 1999 related to the rescission of
two reinsurance treaties. NAICO collected this amount during January 2000.
(3) Chandler Barbados owns 100% of the common stock of Chandler USA, which in turn owns 100% of the common
stock of NAICO. Although Chandler Barbados 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, 1999, Chandler Barbados had cash and investments with a fair
value of $24.1 million deposited in a trust account for the benefit of NAICO.
</TABLE>
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 owed NAICO
approximately $1.3 million for reinsurance recoverables on paid losses and
loss adjustment expenses as of December 31, 1999. NAICO is seeking
arbitration in order to enforce the terms of the reinsurance treaties.
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, allowances are established for
amounts deemed uncollectible. During 1997 and 1998, NAICO incurred charges
of $527,000 and $50,000, respectively, in uncollectible reinsurance
recoverables from unaffiliated reinsurers. NAICO did not incur any charges
for uncollectible reinsurance recoverables from unaffiliated reinsurers
in 1999.
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").
<PAGE>
PAGE 6
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."
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------
1995 1996 1997 1998 1999
---------- ---------- ---------- ---------- -------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Workers compensation:
Net premiums earned................................ $ 28,552 $ 35,273 $ 35,646 $ 9,937 $ 29,244 (2)
Loss ratio......................................... 67% 61% 72% 66% 77% (2)
Other liability:
Net premiums earned................................ $ 4,985 $ 7,022 $ 10,014 $ 11,357 $ 15,785
Loss ratio......................................... 56% 61% 47% 66% 70%
Automobile liability:
Net premiums earned................................ $ 14,218 $ 16,433 $ 13,704 $ 11,419 $ 15,027
Loss ratio......................................... 78% 90% 76% 75% 78%
Surety:
Net premiums earned................................ $ 13,113 $ 9,495 $ 10,671 $ 7,619 $ 8,061
Loss ratio......................................... 50% 10% 8% 18% 6%
Automobile physical damage:
Net premiums earned................................ $ 5,881 $ 6,788 $ 5,726 $ 4,702 $ 7,039
Loss ratio......................................... 66% 73% 60% 86% 104%
Accident and health:
Net premiums earned................................ $ 200 $ 564 $ 2,529 $ 4,610 $ 8,195
Loss ratio......................................... -36% 59% 43% 91% 104%
Property:
Net premiums earned................................ $ 1,369 $ 1,467 $ 1,912 $ 2,332 $ 2,972
Loss ratio......................................... 73% 114% 74% 136% 203%
Inland marine:
Net premiums earned................................ $ 266 $ 1,294 $ 500 $ 448 $ 775
Loss ratio......................................... 42% 113% 196% 126% 138%
Total:
Net premiums earned................................ $ 68,584 $ 78,336 $ 80,702 $ 52,424 $ 87,098 (2)
Loss ratio......................................... 65% 64% 60% 69% 79% (2)
Underwriting expense ratio (1)..................... 41% 44% 38% 33% 32%
---------- ---------- ---------- ---------- -------------
Combined ratio (1)................................. 106% 108% 98% 102% 111% (2)
========== ========== ========== ========== =============
- --------------------------------------------------------
<FN>
(1) Interest expense and litigation expenses are not considered underwriting expenses; therefore, such costs have been
excluded from these ratios. The 1996 underwriting expense ratio was increased by 4 percentage points by a reinsurance
arbitration adjustment and the termination of relations with NAICO's former surety bond underwriting manager.
(2) The rescission of two reinsurance treaties during 1999 increased net premiums earned for workers compensation by $19.6
million and increased the workers compensation loss ratio by 20 percentage points. The rescission of the reinsurance
treaties also increased the total 1999 loss ratio by 2 percentage points and the 1999 combined ratio by 4 percentage
points.
</TABLE>
<PAGE>
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. 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. 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 losses and loss
adjustment expenses were approximately $4.3 million and $3.2 million at
December 31, 1998 and 1999, 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 generally accepted accounting principles ("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>
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.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
1995 1996 1997 1998 1999
---------- ---------- ---------- ---------- ----------
(In thousands)
<S> <C> <C> <C> <C> <C>
Net balance before provision for uncollectible
reinsurance at beginning of year..................... $ 63,610 $ 57,710 $ 53,313 $ 53,345 $ 39,570
---------- ---------- ---------- ---------- ----------
Net losses and loss adjustment expenses
incurred related to:
Current year...................................... 46,011 48,568 46,645 34,313 65,139
Prior years....................................... (1,551) 1,305 1,868 1,737 3,520
---------- ---------- ---------- ---------- ----------
Total.......................................... 44,460 49,873 48,513 36,050 68,659
---------- ---------- ---------- ---------- ----------
Net paid losses and loss adjustment expenses
related to:
Current year...................................... (19,589) (22,502) (19,909) (19,495) (33,210)
Prior years....................................... (30,771) (31,768) (28,572) (30,330) (23,896)
---------- ---------- ---------- ---------- ----------
Total.......................................... (50,360) (54,270) (48,481) (49,825) (57,106)
---------- ---------- ---------- ---------- ----------
Net balance before provision for uncollectible
reinsurance at end of year........................... 57,710 53,313 53,345 39,570 51,123
Adjustments to reinsurance recoverables on
unpaid losses for uncollectible reinsurance.......... 630 532 690 351 255
---------- ---------- ---------- ---------- ----------
Net balance at end of year.............................. $ 58,340 $ 53,845 $ 54,035 $ 39,921 $ 51,378
========== ========== ========== ========== ==========
</TABLE>
The following table represents the development of net balance sheet
reserves for 1990 through 1999. 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
for the last eight years presented.
<PAGE>
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 1993 for
claims that occurred in 1990 will be included in the cumulative deficiency
amount for years 1990, 1991, 1992 and 1993. 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.
<TABLE>
<CAPTION>
DEVELOPMENT OF RESERVES
AS OF DECEMBER 31,
--------------------------------------------------------------------------------------------------
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
--------- --------- --------- --------- --------- --------- --------- --------- --------- --------
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net reserve for unpaid losses and
loss adjustment expenses (1).. $ 40,528 $ 47,432 $ 46,604 $ 51,648 $ 64,308 $ 58,340 $ 53,845 $ 54,035 $ 39,921 $ 51,378
Net paid (cumulative) as of
One year later................ 27,512 27,588 26,849 26,469 30,771 31,768 28,572 30,330 73,721
Two years later............... 40,576 40,797 39,770 38,655 45,321 44,471 40,857 42,934
Three years later............. 44,701 47,379 46,360 45,357 51,985 49,262 45,668
Four years later.............. 46,042 50,798 49,400 48,385 54,825 51,101
Five years later.............. 46,805 52,217 51,299 49,116 55,691
Six years later............... 47,949 53,881 51,641 49,399
Seven years later............. 48,671 54,159 51,867
Eight years later............. 48,770 54,293
Nine years later.............. 48,855
Net liability re-estimated as of (1)
One year later................ 44,820 50,268 51,951 52,058 62,757 59,644 55,713 55,772 43,441
Two years later............... 46,589 51,191 50,845 50,135 61,924 59,605 55,599 56,362
Three years later............. 46,572 51,908 51,076 50,492 62,737 59,155 54,528
Four years later.............. 46,726 52,263 51,572 51,022 62,636 58,247
Five years later.............. 47,042 53,341 52,309 50,981 62,195
Six years later............... 48,375 54,516 52,275 50,954
Seven years later............. 49,259 54,597 52,381
Eight years later............. 49,370 54,618
Nine years later.............. 49,325
Net cumulative (deficiency)
redundancy.................... $ (8,797) $ (7,186) $ (5,777) $ 694 $ 2,113 $ 93 $ (683) $ (2,327) $ (3,520) $ -
Supplemental gross data:
Gross liability after reclassification of pools-
end of year..................................... $210,892 $167,187 $143,437 $116,149 $ 78,114 $ 73,721 $ 80,701 $ 98,460
Reclassification of pool liabilities (1).......... (18,875) (15,694) - - - - - -
--------- --------- --------- --------- --------- --------- --------- --------
Gross liability before reclassification of pools-
end of year (1)................................. $192,017 $151,493 $143,437 $116,149 $ 78,114 $ 73,721 $ 80,701 $ 98,460
Reinsurance recoverable........................... 145,413 99,845 79,129 57,809 24,269 19,686 40,780 47,082
--------- --------- --------- --------- --------- --------- --------- --------
Net liability - end of year (1)................... $ 46,604 $ 51,648 $ 64,308 $ 58,340 $ 53,845 $ 54,035 $ 39,921 $ 51,378
========= ========= ========= ========= ========= ========= ========= ========
Gross re-estimated liability - latest (1)......... $195,488 $150,345 $143,412 $120,024 $ 91,509 $ 87,211 $ 96,208
Re-estimated recoverable - latest................. 143,107 99,391 81,217 61,777 36,981 30,849 52,767
--------- --------- --------- --------- --------- --------- ---------
Net re-estimated liability - latest (1)........... $ 52,381 $ 50,954 $ 62,195 $ 58,247 $ 54,528 $ 56,362 $ 43,441
========= ========= ========= ========= ========= ========= =========
Gross cumulative (deficiency) redundancy.......... $ (3,471) $ 1,148 $ 25 $ (3,875) $(13,395) $(13,490) $(15,507)
========= ========= ========= ========= ========= ========= =========
- ----------------------------------------------------
<FN>
(1) The December 31, 1993 and prior amounts do not include the reclassification of pool liabilities.
</TABLE>
INVESTMENTS
Funds available for investment include Chandler USA's present capital as
well as premiums received and retained under insurance policies and
reinsurance agreements issued by NAICO. Until these funds are required to be
used for the settlement of claims and the payment of operating expenses, they
are invested with the objective of generating income, preserving principal
and maintaining liquidity.
<PAGE>
PAGE 10
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 income tax as a separate
component of shareholder's equity 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, 1999, 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, a collateralized repurchase agreement and common stock
received in connection with two unaffiliated entities' conversion to
for-profit corporations. Approximately $80.4 million of NAICO's
investment portfolio at December 31, 1999 is managed by Madison
Scottsdale, L.C. The remainder is managed by the Investment Committee of
its Board of Directors. For additional information, see Notes to
Consolidated Financial Statements.
DEBENTURE OFFERING
On July 16, 1999, Chandler USA completed a public offering of $24
million principal amount of senior 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 proceeds to Chandler USA before expenses
but after the underwriter's discount were $23.16 million. The proceeds of
the offering were used to repay existing bank debt, to repay amounts owed
by Chandler USA to Chandler Barbados, and for general corporate purposes.
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.
EMPLOYEES AND ADMINISTRATION
At December 31, 1999, Chandler USA and its subsidiaries had
approximately 390 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.
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. Since the
late 1980's, the industry has generally had excess underwriting capacity.
This condition has resulted in depressed premium rates and expanded policy
terms, which generally occur when excess underwriting capacity exists. NAICO
continues to experience pricing competition as the conditions of heightened
price competition and impaired underwriting performance continue in the
industry as a whole.
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.
<PAGE>
PAGE 11
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
Nebraska Insurance Holding Company System Act (the "Holding Company Act"). The
Holding Company Act 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 Holding Company Act 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.
The activities of L&W related to insurance brokerage and agency services
and claims administration services are subject to licensing and regulation by
the jurisdictions in which it conducts such activities. In addition, most
jurisdictions require that certain individuals engaging in brokerage and
agency activities be personally licensed. As a result, a number of L&W's
employees are so licensed.
INSURANCE REGULATION CONCERNING CHANGE OR ACQUISITION OF CONTROL
NAICO is a domestic property and casualty insurance company organized
under the insurance laws of Nebraska (the "Insurance Code"). The 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 Nebraska 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 Nebraska, 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, Chandler Barbados or Chandler USA would also generally
require prior approval by the Nebraska Department of Insurance and would
require pre-acquisition notification in those states which have adopted
pre-acquisition notification provisions and in which the insurers are
admitted. Because such requirements are primarily for the benefit of
policyholders, they may deter, delay or prevent certain transactions that
could be advantageous to the shareholders or creditors of Chandler USA.
RESTRICTIONS ON SHAREHOLDER DIVIDENDS
A significant portion of Chandler USA's consolidated assets represents
assets of NAICO that may not be immediately transferable to Chandler USA in
the form of shareholder dividends, loans, advances or other payments.
Statutes and regulations governing NAICO and other insurance companies
domiciled in Nebraska regulate the payment of shareholder dividends and
other payments by NAICO to Chandler USA. Under applicable Nebraska 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 Nebraska 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
plus statutory net income, excluding realized capital gains, from the second
and third preceding calendar years, that was not paid in dividends or other
distributions; or (ii) 10% of NAICO's statutory policyholders' surplus as of
the preceding calendar year end, not to exceed NAICO's statutory earned
surplus.
<PAGE>
PAGE 12
As of December 31, 1999, NAICO had statutory earned surplus of $11.9
million. Applying the Nebraska statutory limits described above, the maximum
shareholder dividend NAICO may pay in 2000 without the approval of the
Nebraska Department of Insurance is $4.9 million. In January 2000, NAICO
paid a shareholder dividend of $1,250,000 to Chandler USA. NAICO paid a
shareholder dividend of $6.0 million to Chandler USA during 1998.
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:
<TABLE>
<CAPTION>
Ratio of Total Adjusted Capital to
Authorized Control Level RBC
Regulatory Event (1) (Less than or equal to)
-------------------- ----------------------------------------
<S> <C>
Company Action Level (2).......................... 2.0
Regulatory Action Level (3)....................... 1.5
Authorized Control Level (4)...................... 1.0
Mandatory Control Level (5)....................... 0.7
- -------------------------------------------------------
<FN>
(1) When an insurer's ratio exceeds 2.0, it is not subject to regulatory attention under the RBC Model Act.
(2) "Company Action Level" requires an insurer to prepare and submit an RBC Plan to the insurance commissioner of its
state of domicile. After review, the insurance commissioner will notify the insurer if the Plan is satisfactory.
(3) "Regulatory Action Level" requires the insurer to submit an RBC Plan, or if applicable, a Revised RBC Plan to the
insurance commissioner of its state of domicile. After examination or analysis, the insurance commissioner will
issue an order specifying corrective actions to be taken.
(4) "Authorized Control Level" authorizes the insurance commissioner to take such regulatory actions considered
necessary to protect the best interest of the policyholders and creditors of an insurer which may include the
actions necessary to cause the insurer to be placed under regulatory control (i.e., rehabilitation or liquidation).
(5) "Mandatory Control Level" authorizes the insurance commissioner to take actions necessary to place the insurer
under regulatory control (i.e., rehabilitation or liquidation).
</TABLE>
The ratios of total adjusted capital to authorized control level RBC for
NAICO were 7.5:1 and 4.4:1 at December 31, 1998 and 1999, respectively.
Therefore, NAICO's capital exceeds the level that would trigger regulatory
attention pursuant to the risk-based capital requirement.
<PAGE>
PAGE 13
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 11
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. Although
NAICO has not received the official IRIS test results for 1999, management
believes that NAICO had four 1999 ratios that would have been outside of the
"usual values."
In 1999, NAICO experienced a "change in net writings" of 124% compared
to a usual value of plus or minus 33%. NAICO experienced an increase in
gross premiums written of 26% during 1999, and changes in NAICO's reinsurance
programs which reduced NAICO's net retention in 1998, as well as the
rescission of two reinsurance treaties during 1999 (which increased this
ratio by 59 percentage points) were all contributing factors in the increase
in this ratio in 1999.
NAICO's "investment yield" as calculated using the IRIS formula was
3.4% during 1999 compared to a usual value of 4.5% to 10%. NAICO maintains
a high-quality investment portfolio, approximately 10% of which was invested
in tax-exempt bonds as of December 31, 1999. Tax-exempt bonds generally have
a lower pre-tax yield than taxable bonds. During 1999, NAICO incurred
$851,000 in investment expenses to subsidize a premium finance program for
certain insureds of NAICO. While such expenses reduced NAICO's investment
yield, the premium finance program enhances cash flow by providing cash which
is available for investment earlier than conventional deferred payment plans.
The ratio of "agents' balances to surplus" was 47% at December 31, 1999
compared to a usual value of 40% or less. The increase in gross premiums
written during 1999, particularly during the fourth quarter of 1999, was the
primary factor for the increase in this ratio.
NAICO's "estimated current reserve deficiency to surplus" was 34% at
December 31, 1999 compared to a usual value of 25% or less. The primary
factors that affect this ratio were the significant increase in NAICO's net
premiums earned in 1999 and the changes in NAICO's net retention during 1997,
1998 and 1999. 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, product mix, the amount of risk retained by NAICO
and current reserving practices. See "MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" and "Reinsurance."
CODIFICATION
In 1998, the National Association of Insurance Commissioners adopted
codified statutory accounting principles ("Codification"). Codification will
change, to some extent, prescribed statutory accounting practices and will
result in changes to the accounting practices that NAICO uses to prepare its
statutory financial statements. The state of Nebraska has adopted
Codification to be effective January 1, 2001. Management believes the most
significant changes would be the elimination of the statutory liability for
the "excess of statutory reserves over statement reserves" and the
recognition of a deferred tax asset subject to an admissibility test. If
Codification had been in effect at December 31, 1999, NAICO's statutory
surplus would have increased approximately $7.6 million as a result of these
items.
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, 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.
<PAGE>
PAGE 14
ITEM 2. PROPERTIES
Chandler USA and its subsidiaries own and occupy three office buildings
with approximately 81,000 square feet of usable space in Chandler, Oklahoma,
and an additional office building with approximately 46,000 square feet of
usable space is being constructed in Chandler, Oklahoma. Chandler USA's
subsidiaries also lease approximately 10,000 square feet in the aggregate for
its branch offices. Chandler USA believes such space is sufficient for its
operations for the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
CENTRA LITIGATION
Chandler Insurance and certain of its subsidiaries and affiliates have
been involved in litigation with CenTra, Inc. ("CenTra") and certain of its
affiliates, officers and directors (the "CenTra Group") since July 1992.
See Note 10 to Consolidated Financial Statements for a detailed discussion.
See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CenTra Litigation."
OTHER LITIGATION
Chandler USA and its subsidiaries are not parties to any other material
litigation other than as is routinely encountered in their respective
business activities.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Omitted.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
All of the common stock of Chandler USA is owned by Chandler Barbados,
which is a wholly owned subsidiary of Chandler Insurance. The common shares
of the Chandler Insurance trade on The Nasdaq Stock Market under the symbol:
CHANF. 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 14(a). The consolidated balance sheets of Chandler USA and its
subsidiaries as of December 31, 1998 and 1999, 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, 1999,
have been audited by Deloitte & Touche LLP, independent auditors, whose
independent auditors report expresses an unqualified opinion and includes an
explanatory paragraph relating to litigation. The Operating Data for the
year ended December 31, 1995 and the Balance Sheet Data at December 31, 1995
and 1996 have been derived from Chandler USA and its subsidiaries financial
accounts; such accounts having been included in the consolidated financial
statements of Chandler Insurance. The selected financial data should be read
in conjunction with "LEGAL PROCEEDINGS," "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS" and the
consolidated financial statements of Chandler USA and the notes thereto
appearing in Item 14(a). See Notes to Consolidated Financial Statements for
various litigation and contingency matters.
<PAGE>
PAGE 15
ITEM 6. SELECTED FINANCIAL DATA (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
1995 1996 1997 1998 1999
---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
OPERATING DATA
Revenues
Direct premiums written and assumed.............. $ 98,768 $ 108,059 $ 123,088 $ 134,293 $ 169,569
========== ========== ========== ========== ==========
Net premiums earned (1).......................... $ 68,584 $ 78,336 $ 80,702 $ 52,424 $ 87,098
Interest income, net............................. 5,494 5,663 6,130 4,904 3,959
Realized investment gains, net................... 262 157 790 1,036 57
Fee for rescinded reinsurance treaties........... - - - - 10,000
Commissions, fees and other income............... 2,911 3,413 2,345 1,744 1,481
---------- ---------- ---------- ---------- ----------
Total revenues...................................... 77,251 87,569 89,967 60,108 102,595
---------- ---------- ---------- ---------- ----------
Operating expenses
Losses and loss adjustment expenses.............. 44,460 49,873 48,513 36,050 68,659
Policy acquisition costs......................... 21,560 25,833 22,819 10,685 21,160
General and administrative expenses.............. 12,146 14,044 11,984 11,277 10,795
Interest expense................................. 52 146 442 887 1,496
Litigation expenses, net......................... 579 (230) 923 423 207
---------- ---------- ---------- ---------- ----------
Total operating expenses............................ 78,797 89,666 84,681 59,322 102,317
---------- ---------- ---------- ---------- ----------
Income (loss) before income taxes................... (1,546) (2,097) 5,286 786 278
Federal income tax benefit (provision) of
consolidated U.S. subsidiaries................... (812) 317 (2,281) (353) (365)
---------- ---------- ---------- ---------- ----------
Net income (loss)................................... $ (2,358) $ (1,780) $ 3,005 $ 433 $ (87)
========== ========== ========== ========== ==========
Combined loss and underwriting expense ratio (2).... 106% 108% 98% 102% 111%
BALANCE SHEET DATA
Cash and investments................................ $ 93,697 $ 99,098 $ 107,957 $ 94,947 $ 93,666
Total assets........................................ 230,265 198,972 202,787 223,351 256,836
Unpaid losses and loss adjustment expenses.......... 116,149 78,114 73,721 80,701 98,460
Notes payable....................................... 300 4,391 2,796 9,410 -
Amounts due to affiliate............................ 21,583 23,548 19,918 12,219 533
Debentures.......................................... - - - - 24,000
Total liabilities................................... 182,702 154,445 154,351 174,090 210,097
Shareholder's equity................................ 47,563 44,527 48,436 49,261 46,739
- ----------------------------------------------------
<FN>
(1) During 1997 and 1998, NAICO purchased additional reinsurance coverages
which resulted in significantly lower net premiums earned in 1998. See
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS."
(2) Interest expense and litigation expenses are not considered underwriting
expenses; therefore, such expenses have been excluded from this ratio.
The 1996 combined loss and underwriting expense ratio was increased by
four percentage points by a reinsurance arbitration adjustment and the
termination of relations with NAICO's former surety bond underwriting
manager. The rescission of two reinsurance treaties during 1999
increased the 1999 combined loss and underwriting expense ratio by four
percentage points. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS."
</TABLE>
<PAGE>
PAGE 16
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 L&W. NAICO writes
various property and casualty insurance products through four separate
marketing programs: standard property and casualty, political subdivisions,
surety bonds (including both bail bonds and construction bonds) and group
accident and health. The lines of insurance written by NAICO are commercial
coverages consisting of automobile liability, workers compensation, surety,
automobile physical damage, accident and health, property, inland marine and
other liability lines, which include general and professional liability lines.
L&W represents various personal and commercial lines insurance companies in
marketing property and casualty insurance. L&W also markets individual and
group life, medical and disability income coverage. L&W places the majority
of its business with NAICO. Business produced by L&W and placed with NAICO
constituted approximately 23% of NAICO's direct premiums written and assumed
in 1999.
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.
CLAIM COSTS AND LOSS 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 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. 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. 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.
<PAGE>
PAGE 17
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. See Notes to Consolidated Financial Statements.
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 $145 million, or 86%, of NAICO's direct written
premiums in 1999 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. During 1999, the market value of NAICO's available
for sale investments declined by $3.7 million due primarily to higher
interest rates experienced during this time. 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.
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.
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
Nebraska Insurance Holding Company System Act (the "Holding Company Act").
The Holding Company Act 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
Holding Company Act contains special reporting and prior approval
requirements with respect to transactions among affiliates. The Holding
Company Act also imposes certain requirements upon any person controlling or
seeking to control an insurance company domiciled in Nebraska. 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 Holding Company Act. See "BUSINESS - Regulation."
<PAGE>
PAGE 18
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.
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. Since the
late 1980's, the industry has generally had excess underwriting capacity.
This condition has resulted in depressed premium rates and expanded policy
terms, which generally occur when excess underwriting capacity exists. NAICO
continues to experience pricing competition as the conditions of heightened
price competition and impaired underwriting performance continue in the
industry as a whole.
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:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1997 1998 1999
----------- ----------- -----------
(Dollars in thousands)
<S> <C> <C> <C>
INSURANCE PROGRAMS
- -----------------------------------------------
STANDARD PROPERTY AND CASUALTY
Net premiums earned......................... $ 44,887 $ 29,234 $ 56,673
Financial year loss ratio................... 68.4% 76.3% 81.3%
Accident year loss ratio.................... 71.4% 75.3% 78.5%
POLITICAL SUBDIVISIONS
Net premiums earned......................... $ 12,416 $ 10,435 $ 14,320
Financial year loss ratio................... 58.1% 80.5% 102.9%
Accident year loss ratio.................... 66.2% 84.6% 92.1%
SURETY BONDS
Net premiums earned......................... $ 10,533 $ 7,456 $ 7,835
Financial year loss ratio................... 7.9% 17.9% 4.0%
Accident year loss ratio.................... 11.1% 18.0% 7.6%
GROUP ACCIDENT AND HEALTH
Net premiums earned......................... $ 2,303 $ 4,610 $ 8,195
Financial year loss ratio................... 43.3% 89.5% 104.7%
Accident year loss ratio.................... 84.5% 103.5% 83.0%
NONSTANDARD PRIVATE-PASSENGER AUTOMOBILE
Net premiums earned......................... $ 8,841 $ 482 $ 4
Financial year loss ratio................... 72.2% (37.8)% (9,325.2)%
Accident year loss ratio.................... 61.4% 18.2% -%
OTHER
Net premiums earned......................... $ 1,722 $ 207 $ 71
Financial year loss ratio................... 137.9% 24.6% (915.9)%
Accident year loss ratio.................... 77.6% 91.7% 133.0%
TOTAL
Net premiums earned......................... $ 80,702 $ 52,424 $ 87,098
Financial year loss ratio................... 60.1% 68.8% 78.8%
Accident year loss ratio.................... 62.2% 71.0% 74.8%
</TABLE>
<PAGE>
PAGE 19
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1997 1998 1999
----------- ----------- -----------
(Dollars in thousands)
<S> <C> <C> <C>
LINES OF INSURANCE
- -----------------------------------------------
WORKERS COMPENSATION
Net premiums earned......................... $ 35,646 $ 9,937 $ 29,244
Financial year loss ratio................... 72.0% 66.4% 76.8%
Accident year loss ratio.................... 74.1% 67.3% 79.7%
OTHER LIABILITY
Net premiums earned......................... $ 10,014 $ 11,357 $ 15,785
Financial year loss ratio................... 47.1% 66.3% 70.0%
Accident year loss ratio.................... 51.4% 64.5% 57.1%
AUTOMOBILE LIABILITY
Net premiums earned......................... $ 13,704 $ 11,419 $ 15,027
Financial year loss ratio................... 75.7% 75.2% 78.2%
Accident year loss ratio.................... 72.0% 77.4% 76.8%
SURETY
Net premiums earned......................... $ 10,671 $ 7,619 $ 8,061
Financial year loss ratio................... 8.0% 18.1% 5.7%
Accident year loss ratio.................... 11.1% 19.9% 7.9%
AUTOMOBILE PHYSICAL DAMAGE
Net premiums earned......................... $ 5,726 $ 4,702 $ 7,039
Financial year loss ratio................... 60.0% 85.8% 104.0%
Accident year loss ratio.................... 59.7% 87.6% 103.3%
ACCIDENT AND HEALTH
Net premiums earned......................... $ 2,529 $ 4,610 $ 8,195
Financial year loss ratio................... 43.1% 91.1% 103.9%
Accident year loss ratio.................... 82.1% 103.5% 83.0%
PROPERTY
Net premiums earned......................... $ 1,912 $ 2,332 $ 2,972
Financial year loss ratio................... 74.1% 135.8% 202.7%
Accident year loss ratio.................... 75.8% 148.4% 187.7%
INLAND MARINE
Net premiums earned......................... $ 500 $ 448 $ 775
Financial year loss ratio................... 195.6% 125.9% 138.1%
Accident year loss ratio.................... 118.9% 114.6% 126.9%
TOTAL
Net premiums earned......................... $ 80,702 $ 52,424 $ 87,098
Financial year loss ratio................... 60.1% 68.8% 78.8%
Accident year loss ratio.................... 62.2% 71.0% 74.8%
</TABLE>
<PAGE>
PAGE 20
PURCHASE OF ADDITIONAL REINSURANCE
During the second quarter of 1997, management concluded that it would be
in NAICO's best interest to substantially reduce its underwriting risk in the
California portion of the nonstandard private-passenger automobile program.
In July 1997, NAICO purchased additional reinsurance for this portion of the
program.
In 1998, NAICO believed that reinsurance market conditions were conducive
to the purchase of additional reinsurance. During the first quarter of 1998,
NAICO purchased additional reinsurance under its workers compensation and
casualty reinsurance programs. During the second quarter of 1998, NAICO
purchased additional reinsurance for its construction surety bond reinsurance
program. The purchase of the additional reinsurance coverages in 1997 and
1998 substantially reduced the per occurrence retention for NAICO's workers
compensation, casualty, surety bond and nonstandard private-passenger
automobile lines of business, but resulted in significantly lower net
premiums earned, losses and loss adjustment expenses and policy acquisition
costs. The purchase of additional reinsurance also resulted in an increase
in reinsurance recoverables on unpaid losses, prepaid reinsurance premiums
and premiums payable and a decrease in deferred policy acquisition costs.
See "Premiums Earned" and "Policy Acquisition Costs." During the fourth
quarter of 1999, NAICO agreed to rescind two reinsurance treaties which
covered a portion of its workers compensation business and which had been in
effect since January 1, 1999. The reinsurer agreed to return the reinsurance
premiums that had been paid by NAICO during 1999, less losses and ceding
commissions that had been paid by the reinsurer. The reinsurer also agreed
to pay NAICO a fee of $10.0 million as additional compensation for entering
into the agreement. In January 2000, NAICO received payment in the amount of
$12.9 million relating to the transaction.
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 as
of December 31 for each year presented:
<TABLE>
<CAPTION>
INSURANCE PROGRAMS GROSS PREMIUMS EARNED NET PREMIUMS EARNED
- ------------------------------------------ ----------------------------- -----------------------------
1997 1998 1999 1997 1998 1999
--------- --------- --------- --------- --------- ---------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Standard property and casualty............. $ 62,841 $ 76,458 $ 99,512 $ 44,887 $ 29,234 $ 56,673
Political subdivisions..................... 21,503 25,091 29,994 12,416 10,435 14,320
Surety bonds............................... 12,320 11,915 13,660 10,533 7,456 7,835
Group accident and health.................. 3,379 6,067 9,098 2,303 4,610 8,195
Nonstandard private-passenger automobile... 14,303 6,015 118 8,841 482 4
Other...................................... 2,362 488 65 1,722 207 71
--------- --------- --------- --------- --------- ---------
TOTAL...................................... $116,708 $126,034 $152,447 $ 80,702 $ 52,424 $ 87,098
========= ========= ========= ========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
LINES OF INSURANCE GROSS PREMIUMS EARNED NET PREMIUMS EARNED
- ------------------------------------------ ----------------------------- -----------------------------
1997 1998 1999 1997 1998 1999
--------- --------- --------- --------- --------- ---------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Workers compensation...................... $ 47,198 $ 48,699 $ 51,106 $ 35,646 $ 9,937 $ 29,244
Other liability........................... 13,593 17,593 26,260 10,014 11,357 15,785
Automobile liability...................... 20,672 20,005 22,701 13,704 11,419 15,027
Surety.................................... 12,458 12,078 13,886 10,671 7,619 8,061
Automobile physical damage................ 7,072 6,307 8,081 5,726 4,702 7,039
Accident and health....................... 3,697 6,074 9,098 2,529 4,610 8,195
Property.................................. 10,331 12,916 17,196 1,912 2,332 2,972
Inland marine............................. 1,687 2,362 4,119 500 448 775
--------- --------- --------- --------- --------- ---------
TOTAL..................................... $116,708 $126,034 $152,447 $ 80,702 $ 52,424 $ 87,098
========= ========= ========= ========= ========= =========
</TABLE>
<PAGE>
PAGE 21
Gross premiums earned, before reductions for premiums ceded to
reinsurers, increased 13%, 8% and 21% in 1997, 1998 and 1999, respectively.
The increases are primarily attributable to an increase in written premium
production in Texas and Oklahoma, which we believe resulted from increased
marketing efforts in these states and new insurance programs in Texas. Net
premiums earned, after such reductions, increased 3% in 1997, decreased 35%
in 1998 and increased 66% in 1999. The reduction in net premiums earned in
1998 was due primarily to the purchase of additional reinsurance for NAICO's
workers compensation, casualty and nonstandard private-passenger automobile
insurance programs described previously. The rescission of two reinsurance
treaties increased net premiums earned in 1999 by $19.6 million. See
"Purchase of Additional Reinsurance."
Gross premiums earned in the standard property and casualty program
increased 39%, 22% and 30% in 1997, 1998 and 1999, respectively. The
increases are primarily attributable to increased written premium production
in Texas. Net premiums earned increased 41% in 1997, decreased 35% in 1998
and increased 94% in 1999. The reduction in net premiums earned in 1998 was
due primarily to the purchase of additional reinsurance in 1998 as previously
described. The rescission of the reinsurance treaties increased net premiums
earned in 1999 by $17.3 million in this program.
Gross premiums earned in the political subdivisions program increased
11%, 17% and 20% in 1997, 1998 and 1999, respectively, due primarily to
expansion of the school districts portion of the program in Texas and
Missouri and increased written premium production in Oklahoma. Net premiums
earned increased 7% in 1997, decreased 16% in 1998 and increased 37% in
1999. The reduction in net premiums earned in 1998 was due primarily to the
purchase of additional reinsurance in 1998 as previously described. The
rescission of the reinsurance treaties increased net premiums earned in 1999
by $2.3 million in this program.
Gross premiums earned in the surety bond program increased 8% in 1997,
decreased 3% in 1998 and increased 15% in 1999. The increase in 1999 was
due primarily to increased written premium production in California. Net
premiums earned in the surety bond program increased 12% in 1997, decreased
29% in 1998 and increased 5% in 1999. Increased competition, higher
reinsurance costs and/or changes in risk retained contributed to the decline
in 1998.
Gross premiums earned in the group accident and health program increased
560%, 80% and 50% in 1997, 1998 and 1999, respectively, and net premiums
earned increased 626%, 100% and 78% in 1997, 1998 and 1999, respectively.
The significant increases in premiums in 1997 and 1998 are primarily the
result of the growth expected in start-up programs. In January 1999, NAICO
began a new program covering primarily Oklahoma employers on a fully insured
basis. Gross and net premiums earned for this program were $6.0 million and
$5.6 million, respectively, during 1999. NAICO discontinued writing new
policies for the excess portion of its group accident and health program
effective April 1, 1999. NAICO expects that premiums in its fully insured
program will decline during 2000 due to the effect of rate increases and
other changes in the program which were put in effect in late 1999. NAICO
is currently evaluating the fully insured program and may modify or
discontinue it during 2000.
Nonstandard private-passenger automobile gross premiums earned decreased
14%, 58% and 98% in 1997, 1998 and 1999, respectively. Net premiums earned
in the nonstandard private-passenger automobile program decreased 47%, 95%
and 99% in 1997, 1998 and 1999, respectively. During 1997, NAICO
discontinued the Oklahoma and Arizona portions of its nonstandard
private-passenger automobile program. Effective July 1, 1997, NAICO entered
into a 100% quota share reinsurance agreement to fully reinsure the risk in
the California portion of the program. NAICO has discontinued the California
program.
Other programs in the preceding table include premiums from 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, in addition to the runoff of various programs which are no longer
offered by NAICO. The majority of the decrease in net premiums earned
during the periods is attributable to participation in the pools covering
workers compensation and from direct assignments. The declines were
attributable to decreased activity from the pools and fewer assignments in
certain states. Both the size of the involuntary market and NAICO's
relative participation in states having a mandatory pool mechanism declined
in these years.
NET INTEREST INCOME AND NET REALIZED INVESTMENT GAINS
At December 31, 1999, Chandler USA's investment portfolio consisted
primarily of fixed income U.S. Government, high-quality corporate and tax
exempt bonds, with approximately 5% 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.
<PAGE>
PAGE 22
Net interest income increased 8% in 1997 and decreased 20% and 19% in
1998 and 1999, respectively. The decrease in 1998 was due primarily to lower
interest rates in 1998 and a reduction in invested assets due to the purchase
of additional reinsurance in 1998. In addition, during the fourth quarter of
1997, NAICO shifted a portion of its fixed maturities portfolio from taxable
to tax exempt bonds (which generally have a lower before-tax yield). In
late 1998 and the first quarter of 1999, NAICO shifted approximately half of
its investment in tax exempt bonds to taxable bonds. Net income from tax
exempt securities was $112,000, $1.0 million and $483,000 in 1997, 1998 and
1999, respectively. The decrease in net interest income in 1999 was due
primarily to a reduction in invested assets due to the purchase of additional
reinsurance. Net realized investment gains were $790,000, $1 million and
$57,000 in 1997, 1998 and 1999, respectively.
The average net yield on Chandler USA's portfolio, including net
realized investment gains, was 6.5%, 5.9% and 4.3% in 1997, 1998 and 1999,
respectively. The average net yield on the portfolio, excluding net
realized investment gains, was 5.9%, 5.5% and 4.2% for 1997, 1998 and 1999,
respectively. The decrease in the average net yield in 1999 was due
primarily to an increase in 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, 1999 was approximately $14 million. The average yield on the
portfolio before deducting investment expenses was 6.3%, 5.7% and 5.6% in
1997, 1998 and 1999, respectively, excluding capital gains.
FEE FOR RESCINDED REINSURANCE TREATIES
During the fourth quarter of 1999, NAICO agreed to rescind two
reinsurance treaties which covered a portion of its workers compensation
business and which had been in effect since January 1, 1999. The reinsurer
agreed to return the reinsurance premiums that had been paid by NAICO during
1999, less losses and ceding commissions that had been paid by the reinsurer.
The reinsurer also agreed to pay NAICO a fee of $10.0 million as additional
compensation for entering into the agreement.
COMMISSIONS, FEES AND OTHER INCOME
Chandler USA's income from commissions, fees and other income decreased
31%, 26% and 15% for 1997, 1998 and 1999, respectively. The majority of
Chandler USA's income from commissions, fees and other income are from L&W's
brokerage commissions and fees.
L&W's brokerage commissions and fees before intercompany eliminations
were $9.0 million in 1997, $8.5 million in 1998 and $9.6 million in 1999. A
large portion of the brokerage commissions and fees for L&W is incurred by
NAICO and thus eliminated in the consolidation of Chandler USA's subsidiaries.
L&W disposed of certain equipment in 1998 that resulted in a gain of
approximately $145,000 which was included in other income.
Fees generated by Network Administrators, Inc. ("Network"), a wholly
owned subsidiary of Chandler USA, were $435,000 in 1997. Network no longer
functions as a third-party administrator.
LOSSES AND LOSS ADJUSTMENT EXPENSES
Chandler USA estimates losses and loss adjustment expenses based on
historical experience and payment and reporting patterns for the type of risk
involved. These estimates are based on data available at the time of the
estimate and are periodically reviewed by independent professional actuaries.
See "BUSINESS - Reserves."
The percentage of losses and loss adjustment expenses to net premiums
earned ("loss ratio") was 60.1%, 68.8% and 78.8% in 1997, 1998 and 1999,
respectively. The rescission of the reinsurance treaties increased losses
and loss adjustment expenses in 1999 by $17.0 million. Excluding the effect
of the reinsurance rescission, the loss ratio was 76.6% in 1999.
Weather-related losses (net of applicable reinsurance) from wind and hail
were $459,000, $1.4 million and $4.3 million in 1997, 1998 and 1999,
respectively, and increased the respective loss ratios by 0.6, 2.7 and 6.4
percentage points (excluding the effect of the reinsurance rescission in 1999).
<PAGE>
PAGE 23
NAICO is a major insurer of property owned by businesses, cities, towns
and school districts in Oklahoma. As a result, NAICO incurs weather-related
losses. On May 3, 1999, tornadoes, hail and strong winds caused severe damage
to property owned or used by NAICO insureds. NAICO estimates total insured
damages from the storms at approximately $26.4 million. Giving effect to
NAICO's applicable reinsurance, all of which is with unaffiliated reinsurers,
NAICO estimates its net loss before income tax benefit resulting from the
May 3, 1999 storms at $1.8 million which was recorded in the second quarter
of 1999.
POLICY ACQUISITION COSTS
Policy acquisition costs consist of costs associated with the
acquisition of new and renewal business and generally include direct costs
such as premium taxes, commissions to agents and ceding companies and
premium-related assessments and indirect costs such as salaries and expenses
of personnel who perform and support underwriting activities. NAICO also
receives ceding commissions from the reinsurers who assume premiums from
NAICO under certain reinsurance contracts and the ceding commissions are
accounted for as a reduction of policy acquisition costs. Direct policy
acquisition costs and ceding commissions are deferred and amortized over the
terms of the policies. Recoverability of such deferred costs is dependent
on the related unearned premiums on the policies being more than expected
claim losses. NAICO considers anticipated interest income in determining if
a premium deficiency exists.
The following table sets forth Chandler USA's policy acquisition costs
for each of the three years ended December 31, 1997, 1998 and 1999:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------
1997 1998 1999
---------- ---------- -----------
(In thousands)
<S> <C> <C> <C>
Commissions expense......................... $ 15,860 $ 15,472 $ 20,532
Other premium related assessments........... 744 928 1,214
Premium taxes............................... 3,400 3,144 3,179
Excise taxes................................ 153 161 236
Dividends to policyholders.................. 1,155 242 324
Other expense............................... 146 151 205
---------- ---------- -----------
Total direct expenses....................... 21,458 20,098 25,690
Indirect underwriting expenses.............. 12,937 13,808 16,354
Commissions received from reinsurers........ (11,571) (26,776) (17,670)
Adjustment for deferred acquisition costs... (5) 3,555 (3,214)
---------- ---------- -----------
Net policy acquisition costs................ $ 22,819 $ 10,685 $ 21,160
========== ========== ===========
</TABLE>
Total gross direct and indirect expenses as a percentage of direct
written and assumed premiums were 27.9%, 25.2% and 24.8% in 1997, 1998 and
1999, respectively. For these periods, commission expense as a percentage of
gross written and assumed premiums was 12.9%, 11.5% and 12.1%. Indirect
underwriting expenses were 10.5%, 10.3% and 9.6% of total direct written and
assumed premiums in 1997, 1998 and 1999, 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 NAICO's overall premium volume.
NAICO received commissions totaling approximately $1.9 million and
$909,000 during 1997 and 1998, respectively, under the quota-share
reinsurance arrangement for the California portion of the nonstandard
private-passenger automobile program which was effective July 1, 1997.
During 1998 and 1999, NAICO received commissions from reinsurers totaling
approximately $13.8 million and $4.6 million, respectively, related to the
purchase of additional reinsurance under its workers compensation and
casualty reinsurance programs. Commissions received from reinsurers included
the return of $9.7 million in ceding commissions during the fourth quarter of
1999 related to the rescission of the reinsurance treaties discussed
previously. Net policy acquisition costs increased $7.0 million in 1999 due
to the rescission of the reinsurance treaties, net of the adjustment for
deferred acquisition costs. See "Purchase of Additional Reinsurance."
<PAGE>
PAGE 24
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were 10.1%, 8.8% and 7.0% of gross
premiums earned and commissions, fees and other income (excluding the fee
related to the rescission of the reinsurance treaties) in 1997, 1998 and
1999, respectively. 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. General
and administrative expenses decreased 5.9% in 1998, due primarily to a
reduction in costs attributable to Network. Network ceased functioning as a
third party administrator during 1997. General and administrative expenses
decreased 4.3% in 1999.
INTEREST EXPENSE
Interest expense increased 203%, 101% and 69% in 1997, 1998 and 1999,
respectively. The increase in 1997 and 1998 were due primarily to increased
levels of bank debt. The increase in 1999 was due primarily to interest
expense on the $24 million debenture offering which was completed on July 16,
1999 by Chandler USA. See "Liquidity and Capital Resources."
LITIGATION EXPENSES
Litigation expenses reflect expenses related to the ongoing legal
proceedings involving the CenTra Group. Litigation expenses were $923,000 in
1997 compared to $423,000 in 1998 and $207,000 in 1999. Increased or renewed
activity could result in greater litigation expenses in 2000 or future years.
Certain litigation expenses may be recovered from Chandler Insurance's
directors and officers liability insurer ("D&O Insurer"). As a result of
various events in 1995, Chandler Barbados and Chandler USA recorded $654,000
and $164,000, respectively, estimated recoveries of costs from the D&O Insurer
related to a $1 million claim for reimbursable amounts previously paid that
relate to allowable defense and litigation costs for such parties. In 1996,
Chandler Barbados and Chandler USA recorded additional estimated recoveries
of $102,000 and $880,000, respectively. Chandler Barbados and Chandler USA
received payments for the 1995 claim during 1996 in the amount of $636,000
and $159,000, respectively. In connection with the U.S. District Court in
Oklahoma City, Oklahoma ("Oklahoma Court") judgments, Chandler Barbados
recorded an additional estimated recovery of $2.7 million from the D&O
Insurer. Chandler Insurance and its subsidiaries are entitled to a total of
$5 million under the applicable insurance policy to the extent they have
advanced reimbursable expenses. Some amounts have been previously paid
without dispute and Chandler Insurance is negotiating with the D&O Insurer
for payment of the policy balance. Chandler Insurance and its subsidiaries
could recover the remaining policy limits or could compromise their claim,
and could incur significant costs in either case. The estimated insurance
recovery is based upon these variable factors.
See "CenTra Litigation" and Note 10 to Consolidated Financial Statements.
NET INCOME (LOSS)
As a result of the factors described above, Chandler USA reported a net
loss of $87,000 in 1999 compared to net income of $433,000 in 1998 and $3.0
million in 1997.
The rescission of the reinsurance treaties resulted in a net after tax
gain of $3.8 million during 1999. The rescission of the reinsurance treaties
increased net premiums earned by $19.6 million in the fourth quarter of 1999.
The rescission also increased losses and loss adjustment expenses by
$17.0 million, and increased expenses for policy acquisition costs by
$7.0 million. NAICO received a fee of $10.0 million as additional
compensation for entering into the agreement. The provision for federal
income taxes increased by $1.9 million in 1999 due to the rescission of the
reinsurance treaties.
<PAGE>
PAGE 25
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.
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 income
tax as a separate component of shareholder's equity until realized.
In 1997, Chandler USA provided $8.1 million in cash from operations.
During 1998, Chandler USA used $10.3 million in cash from operations due
primarily to the purchase of additional reinsurance described previously.
During 1999, Chandler USA provided $5.2 million in cash from operations.
Cash flows from investing activities were primarily the result of normal
purchases and sales of investment securities, and in 1997 NAICO sold the
common stock of Century Business Services, Inc. for a total of approximately
$2.5 million. The Century Business Services common stock was received as a
part of NAICO's 1996 settlement with a former underwriting manager. Net
realized investment gains before income taxes were $790,000, $1.0 million and
$57,000 during 1997, 1998 and 1999, respectively, from the sale of
investments. In addition, NAICO received proceeds of $36.2 million and $4.2
million during 1998 and 1999, respectively, from the sale of available for
sale fixed-income securities prior to their maturity. In 1998, to augment
maturities and reposition its portfolio, NAICO chose to liquidate certain
fixed maturity securities that were available for sale prior to their
maturities. The average maturity of NAICO's investments was 4.5 years and
4.0 years at December 31, 1998 and 1999, respectively.
NAICO is required to deposit securities with regulatory agencies in
several states in which it is licensed as a condition of conducting
operations in the state. At December 31, 1999, the total amount of cash and
investments restricted as a result of these arrangements was $7.2 million.
Cash flows from financing activities are affected by the level of
activity related to transactions with affiliates and bank borrowings. In
February 1998, Chandler USA entered into a five-year loan agreement with a
bank having a principal amount of $2.3 million. The loan was collateralized
by certain equipment which was purchased with the proceeds of the loan. The
equipment had previously been leased by Chandler USA. In March 1998,
Chandler USA borrowed an additional $6.2 million under an existing loan
agreement with a bank and the proceeds were used to repay amounts due to
Chandler Barbados. The bank note was collateralized by shares of NAICO stock
owned by Chandler USA. In July 1999, both bank notes were repaid from the
proceeds of the debenture offering.
On July 16, 1999, Chandler USA completed a public offering of $24
million principal amount of senior 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 proceeds to Chandler USA before expenses but after
the underwriter's discount were $23.16 million. The proceeds of the offering
were used to repay existing bank debt, to repay amounts owed by Chandler USA
to its parent Chandler Barbados, and for general corporate purposes.
<PAGE>
PAGE 26
CENTRA LITIGATION
In 1992, Chandler USA and its affiliates became involved in certain legal
proceedings beyond the ordinary course of business. Note 10 to Consolidated
Financial Statements describes the extensive CenTra litigation related to
Chandler USA and its affiliates and the CenTra Group.
During December 1999, Chandler Insurance acquired 1,989,200 shares of
its own stock in exchange for payment of $15,204,758 to CenTra and its
affiliates pursuant to a divestiture plan proposed by NAICO and approved by
the U.S. District Court for the District of Nebraska ("Nebraska Court"). All
shares were canceled upon their return to Chandler Insurance. Based on an
April 22, 1997 judgment by the Oklahoma Court, Chandler Insurance had
previously recorded the return of 517,500 of the 1,989,200 shares as a
decrease to shareholders' equity during 1997. The Nebraska Court had
ordered CenTra to divest all shares of Chandler Insurance owned or
controlled by it or its affiliates. An additional share block owned by
CenTra and affiliates consists of 1,142,625 shares which will be divested
following a ruling on CenTra's appeal of a judgment entered by an Oklahoma
Court in April 1997. That judgment requires CenTra to transfer the shares
to Chandler Insurance in exchange for payment of $6,882,500. Based on the
April 22, 1997 judgment and subsequent actions by the Oklahoma Court,
Chandler Insurance previously recorded the return of the 1,142,625 shares as
a decrease to shareholders' equity during 1997. Following the conclusion of
the appeal, the Nebraska Court will determine the method of divestiture of
these shares. The appellate court heard oral arguments on November 15,
1999. Chandler Insurance cannot predict when the appellate court will rule
on the appeal.
While Chandler USA believes that it is likely that Chandler Insurance
and certain of its subsidiaries, including Chandler USA, will ultimately
prevail as to all material claims asserted in the CenTra litigation, should
the CenTra litigation be modified, reversed or decided adversely to either
Chandler USA or NAICO, such event could result in additional legal and other
expenses for Chandler USA and NAICO and court judgments against NAICO,
impairing the ability of NAICO to pay dividends or other payments to
Chandler USA.
YEAR 2000 READINESS DISCLOSURES
YEAR 2000 UPDATE
Through the first two months of the year 2000, Chandler USA had not
experienced any significant problems or disruptions related to Year 2000
Problems (as described below). Chandler USA is currently not aware of
any significant disruptions experienced by its customers, vendors and
service providers that would materially affect their ability to do business
with Chandler USA. While it is possible that certain Year 2000 Problems may
exist but have not yet materialized, Chandler USA does not currently expect
any Year 2000 Problems to be encountered for the remainder of the year 2000
that would have a material adverse effect on the operating results of
Chandler USA.
YEAR 2000 READINESS OVERVIEW
Computer software, hardware, microprocessor chips and other computer
equipment use two digits to identify a particular year, and therefore may not
recognize the number "00" or may recognize it as a year prior to 1999.
Unless computer equipment and software programs are modified to correct these
data recognition problems (the "Year 2000 Problems"), errors could result.
These errors could cause damage to personal property and disrupt business
practices and functions. In addition to potential problems from computer
systems, potential problems could arise from equipment with embedded chips,
such as vaults, elevators, aircraft and other systems not generally
classified as information technology systems.
Chandler USA is heavily dependent upon complex information technology
computer systems for its operations. Chandler USA has taken action to
attempt to identify the nature and extent of the work required to assess and
remediate Year 2000 Problems with respect to its systems, products and
infrastructures, including non-information technology systems, none of which
are considered critical to operations. Chandler USA began work in 1995 to
prepare its financial, information and other computer-based systems for the
year 2000, including updating existing legacy systems, and such work is
complete at this time. Chandler USA estimates that it has spent $350,000
updating these systems to address Year 2000 Problems, and such costs were
expensed as they were incurred, primarily in 1996 and 1997.
During the fourth quarter of 1998, Chandler USA retained an independent
consultant to prepare a plan for testing its information technology systems.
In late 1998, Chandler USA determined that the testing would be performed by
its employees, and this testing was completed during the first half of 1999.
During the fourth quarter of 1998, Chandler USA incurred approximately
$150,000 in additional expenses to evaluate its information systems and in
preparation of plans to test its information systems.
<PAGE>
PAGE 27
Chandler USA incurred additional costs of approximately $125,000 to
complete its testing during the first six months of 1999. These costs
included the use of internal employees, cost of external software to enhance
testing efforts and computer rental costs. These costs were expensed during
1999 as incurred. Chandler USA could incur costs in the future if additional
efforts are needed to perform modifications to Chandler USA's information
technology systems. Chandler USA has established a contingency plan for all
critical business operations. The contingency plan includes possible manual
operations and the implementation of alternative information processing
procedures.
Chandler USA believes, based on the information currently available, that
the most reasonably likely worst case scenarios resulting from Year 2000
Problems include:
- Legal risks arising from failure of NAICO or L&W to provide contracted
services, deal with claims on a timely basis, provide pertinent data to
those dependent upon the data and similar risks;
- Increased operational costs due to manual processing, data corruption
or disaster recovery;
- Inability to bill or invoice;
- Lost revenue resulting from the inability to render accurate billings
and from the inability to efficiently market insurance products;
- Increased legal and accounting expenses;
- Fines and associated expenses resulting from inability to comply with
regulatory requirements; and
- Failure of management controls.
Any previously mentioned Year 2000 Problems could have a material
adverse effect on Chandler USA, including the financial condition of Chandler
USA's subsidiaries and their ability to pay dividends or other payments to
Chandler USA and its subsidiaries.
It is possible that the credit or operating ability of agents,
reinsurers and others with whom Chandler USA maintains commercial
relationships may be adversely affected by one or more unforeseen
circumstances caused by Year 2000 Problems. However, Chandler USA does not
have control over these third parties and, as a result, it cannot currently
determine to what extent future operating results may be adversely affected
by the failure of these third parties to successfully address their Year 2000
Problems. However, Chandler USA has developed plans to attempt to minimize
identified third-party exposures. Chandler USA has requested information
from its major vendors and service providers to assess their year 2000
readiness. Chandler USA cannot predict the adverse impact, if any, of Year
2000 Problems upon parties with whom it does business.
Chandler USA continues to study the complex issues related to insurance
coverage for losses arising from the myriad potential fact situations
connected with Year 2000 Problems and NAICO's liability to its insureds.
Chandler USA believes that the coverages NAICO provides do not extend to the
types of losses which are most likely to occur as a result of Year 2000
Problems, and NAICO has made no provisions for loss reserves based on
potential Year 2000 Problems. NAICO expects to utilize coverage exclusion
endorsements based on the individual underwriting of commercial accounts, and
it has adopted endorsements to its policies based on forms provided and filed
for approval with various regulatory authorities by Insurance Services Office,
Inc., an insurance services company which provides regulatory research and
filing support to insurance companies. Use of these special endorsements is
governed by the law and regulatory policies of states in which NAICO is
authorized to do business.
It is possible that future court interpretations of policy language
based on specific facts, or legislation mandating coverage, could result in
coverage for losses attributable to Year 2000 Problems. Such decisions or
legislation could have a material adverse impact on Chandler USA. It is also
possible that NAICO may incur expenses defending claims for which it is
ultimately determined there is no insurance coverage.
ACCOUNTING STANDARD ISSUED BUT NOT YET ADOPTED
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, ACCOUNTING FOR
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. SFAS No. 133 establishes
accounting and reporting standards for derivative instruments, including
certain derivative instruments embedded in other contracts, and for hedging
activities. It requires that Chandler USA recognize all derivatives as
either assets or liabilities in the statement of financial condition and
measure those instruments at fair value. The accounting for changes in the
fair value of a derivative depends on the intended use of the derivative and
the resulting designation. Chandler USA will adopt SFAS No. 133 when
required. Chandler USA's management does not expect that adoption of SFAS
No. 133 will have a material impact on Chandler USA's consolidated financial
condition or results of operations.
<PAGE>
PAGE 28
FORWARD-LOOKING STATEMENTS
Some of the statements made in this Form 10-K report, as well as
statements made by Chandler USA in periodic press releases, oral statements
made by Chandler USA's officials to analysts and shareholders in the course
of presentations about Chandler USA and conference calls following earnings
releases, 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 operates; (iv) claims frequency;
(v) claims severity; (vi) the number of new and renewal policy applications
submitted by Chandler USA's agents; (vii) the ability of NAICO to obtain
adequate reinsurance in amounts and at rates that will not adversely affect
its competitive position; (viii) the ability of NAICO to maintain favorable
insurance company ratings; (ix) the ability of Chandler USA and its third
party providers, agents and reinsurers to adequately address year 2000 issues;
and (x) other factors including the ongoing litigation matters involving a
significant concentration of ownership of Chandler USA's indirect parent's
common stock.
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 31,1999, 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 a collateralized repurchase agreement. NAICO does
not hold any investments classified as trading account assets or derivative
financial instruments.
The table below summarizes the estimated effects of hypothetical
increases and decreases in interest rates on NAICO's fixed-maturity investment
portfolio. It is assumed that the changes occur immediately and uniformly,
with no effect given to any steps that management might take to counteract
that change. The hypothetical changes in market interest rates reflect what
could be deemed best and worst case scenarios. The fair values shown in the
following table are based on contractual maturities. Significant variations
in market interest rates could produce changes in the timing of repayments due
to prepayment options available. The fair value of such instruments could be
affected and, therefore, actual results might differ from those reflected in
the following table:
<TABLE>
<CAPTION>
Estimated
Hypothetical fair value after
change in hypothetical
Fair value at interest rate change in
December 31, (bp=basis points) interest rate
--------------------- ---------------------- ---------------------
1998 1999 (Dollars in thousands) 1998 1999
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Fixed-maturity investments (1)... $ 81,309 $ 88,275 100 bp increase....... $ 78,466 $ 85,625
200 bp increase....... 75,789 83,117
100 bp decrease....... 84,331 91,077
200 bp decrease....... 87,547 94,041
- ---------------------------------
<FN>
(1) The fair value at December 31, 1998 excludes short-term investments with
a fair value of $4.3 million as management does not feel that these
investments are exposed to significant interest rate risk due to their
maturity dates. Chandler USA did not hold any short-term investments at
December 31,1999.
</TABLE>
The table above illustrates, for example, that an instantaneous 200 basis
point increase in market interest rates at December 31, 1999 would reduce the
estimated fair value of NAICO's fixed-maturity investments by approximately
$5.2 million at that date.
Chandler USA is obligated for senior debentures that have a maturity date
of July 16, 2014. The debentures have a fixed interest rate of 8.75% and are
redeemable on or after July 16, 2009 without penalty or premium.
<PAGE>
PAGE 29
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Item 14 (a) 1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Omitted.
ITEM 11. EXECUTIVE COMPENSATION
Omitted.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Omitted.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Omitted.
<PAGE>
PAGE 30
PART IV
ITEM 14. 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, 1998 and 1999, 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, 1999, together with the
related notes thereto and the report of Deloitte & Touche LLP,
independent auditors on such financial statements as of December
31, 1999 and for the three years then ended are filed as a part of
this Form 10-K. See accompanying Index on page F-1.
2. FINANCIAL STATEMENT SCHEDULES. The financial statement schedules
listed in the accompanying index to consolidated financial
statements and schedules are filed as part of this Form 10-K. All
other schedules have been omitted since the required information
is not applicable or is not present in amounts sufficient to
require submission of the schedule or because the information is
included in the consolidated financial statements or the notes
thereon.
3. EXHIBITS.
3.1 Certificate of Incorporation. (1)
3.2 Bylaws, as amended. (1)
4.1 Form of Indenture entered into by and between the Company as
issuer and U.S. Trust of Texas, N.A. as trustee. (1)
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 an between Chandler (U.S.A.), Inc. and Brenda
B. Watson. (1)
21.1 Subsidiaries of the registrant.
27.1 Financial Data Schedule (EDGAR version only).
- -----------------------------
(1) Previously filed as an exhibit to Registration No. 333-76393
on Form S-1 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.
No report on Form 8-K was filed by Chandler USA during or applicable to
the quarter ended December 31, 1999.
<PAGE>
PAGE 31
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 ORGANIZED.
CHANDLER (U.S.A.), INC.
Date: March 20, 2000 By:/s/ W. Brent LaGere
-------------------------------------------------
W. Brent LaGere
Chairman of the Board, President
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 DATE INDICATED.
Date: March 20, 2000 /s/ W. Brent LaGere
-------------------------------------------------
W. Brent LaGere, Chairman of the Board,
Chief Executive Officer,
President and Director (Principal Executive
Officer)
Date: March 20, 2000 /s/ Mark T. Paden
-------------------------------------------------
Mark T. Paden, Executive Vice President,
Chief Operating Officer, Chief Financial Officer
and Director (Principal Financial Officer)
Date: March 20, 2000 /s/ Mark C. Hart
-------------------------------------------------
Mark C. Hart, Vice President - Finance and
Treasurer
(Principal Accounting Officer)
Date: March 20, 2000 /s/ Richard L. Evans
-------------------------------------------------
Richard L. Evans, Senior Vice President and
Director
Date: March 20, 2000 /s/ R. Patrick Gilmore
-------------------------------------------------
R. Patrick Gilmore, Senior Vice President,
General Counsel and Director
Date: March 20, 2000 /s/ Robert L. Rice
-------------------------------------------------
Robert L. Rice, Director
<PAGE>
PAGE 32
Date: March 20, 2000 /s/ Robert A. Anderson
------------------------------------------------
Robert A. Anderson, Director
Date: March 20, 2000 /s/ W. Timothy Runyan
------------------------------------------------
W. Timothy Runyan, Director
Date: March 20, 2000 /s/ W. Scott Martin
------------------------------------------------
W. Scott Martin, Director
<PAGE>
PAGE F-1
CHANDLER (U.S.A.), INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
<TABLE>
<CAPTION>
PAGES
------------------
<S> <C>
FINANCIAL STATEMENTS
Consolidated Balance Sheets as of December 31, 1998 and 1999................... F-2
Consolidated Statements of Operations for the years ended
December 31, 1997, 1998 and 1999............................................ F-3
Consolidated Statements of Comprehensive Income for the years ended
December 31, 1997, 1998 and 1999............................................ F-4
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1998 and 1999............................................ F-5
Consolidated Statements of Shareholder's Equity for the years ended
December 31, 1997, 1998 and 1999............................................ F-6
Notes to Consolidated Financial Statements..................................... F-7 through F-24
Independent Auditors' Report on Consolidated Financial Statements
and Financial Statement Schedules........................................... F-25
SCHEDULES
I Summary of Investments - Other Than Investments in Related Parties....... F-26
II Condensed Financial Information of Registrant............................ F-27 through F-29
III Supplementary Insurance Information...................................... F-30
IV Reinsurance.............................................................. F-31
V Valuation and Qualifying Accounts........................................ F-32
VI Supplemental Information (for property-casualty insurance underwriters).. F-33
</TABLE>
<PAGE>
PAGE F-2
CHANDLER (U.S.A.), INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands except share amounts)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1998 1999
---------- ----------
<S> <C> <C>
ASSETS
Investments
Fixed maturities available for sale, at fair value
Restricted.............................................................. $ 7,702 $ 6,826
Unrestricted............................................................ 76,567 80,410
Fixed maturities held to maturity, at amortized cost
Restricted (fair value $354 and $176 in 1998 and 1999, respectively).... 344 169
Unrestricted (fair value $978 and $863 in 1998 and 1999, respectively).. 839 815
Equity securities available for sale, at fair value........................ 191 306
---------- ----------
Total investments....................................................... 85,643 88,526
Cash and cash equivalents..................................................... 9,304 5,140
Premiums receivable, less allowance for non-collection
of $200 and $263 at 1998 and 1999, respectively............................ 28,468 47,717
Reinsurance recoverable on paid losses, less allowance for
non-collection of $275 at 1998 and 1999.................................... 2,760 3,281
Reinsurance recoverable on unpaid losses, less allowance for
non-collection of $330 and $302 at 1998 and 1999, respectively............. 28,867 37,540
Reinsurance recoverable on unpaid losses from related parties................. 11,913 9,542
Prepaid reinsurance premiums.................................................. 22,448 19,960
Prepaid reinsurance premiums to related parties............................... 7,168 9,604
Deferred policy acquisition costs............................................. - 3,134
Property and equipment, net................................................... 8,071 10,719
Licenses, net................................................................. 4,194 4,044
Excess of cost over net assets acquired, net.................................. 4,604 3,956
Other assets.................................................................. 9,911 13,673
---------- ----------
Total assets.................................................................. $ 223,351 $ 256,836
========== ==========
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Unpaid losses and loss adjustment expenses................................. $ 80,701 $ 98,460
Unearned premiums.......................................................... 50,647 67,769
Policyholder deposits...................................................... 4,936 5,135
Notes payable.............................................................. 9,410 -
Accrued taxes and other payables........................................... 3,755 6,544
Premiums payable........................................................... 10,960 7,313
Premiums payable to related parties........................................ 1,462 343
Amounts due to affiliate................................................... 12,219 533
Debentures................................................................. - 24,000
---------- ----------
Total liabilities....................................................... 174,090 210,097
---------- ----------
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........................................................ (12,040) (12,127)
Accumulated other comprehensive income (loss):
Unrealized gain (loss) on investments available for sale, net
of deferred income taxes................................................ 715 (1,720)
---------- ----------
Total shareholder's equity.............................................. 49,261 46,739
---------- ----------
Total liabilities and shareholder's equity.................................... $ 223,351 $ 256,836
========== ==========
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
<PAGE>
PAGE F-3
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1997 1998 1999
---------- ---------- ----------
<S> <C> <C> <C>
Premiums and other revenues
Direct premiums written and assumed........................................ $ 123,088 $ 134,293 $ 169,569
Reinsurance premiums ceded................................................. (26,221) (68,793) (41,698)
Reinsurance premiums ceded to related parties.............................. (15,310) (18,878) (23,599)
---------- ---------- ----------
Net premiums written and assumed........................................ 81,557 46,622 104,272
Decrease (increase) in unearned premiums................................... (855) 5,802 (17,174)
---------- ---------- ----------
Net premiums earned..................................................... 80,702 52,424 87,098
Interest income, net.......................................................... 6,130 4,904 3,959
Realized investment gains, net................................................ 790 1,036 57
Fee for rescinded reinsurance treaties........................................ - - 10,000
Commissions, fees and other income............................................ 2,345 1,744 1,481
---------- ---------- ----------
Total premiums and other revenues....................................... 89,967 60,108 102,595
---------- ---------- ----------
Operating costs and expenses
Losses and loss adjustment expenses, net of amounts ceded
to related parties of $11,510, $12,484 and $11,239
in 1997, 1998 and 1999, respectively.................................... 48,513 36,050 68,659
Policy acquisition costs, net of ceding commissions received
from related parties of $5,114, $6,916 and $8,403 in
1997, 1998 and 1999, respectively....................................... 22,819 10,685 21,160
General and administrative expenses........................................ 11,984 11,277 10,795
Interest expenses.......................................................... 442 887 1,496
Litigation expenses, net................................................... 923 423 207
---------- ---------- ----------
Total operating costs and expenses...................................... 84,681 59,322 102,317
---------- ---------- ----------
Income before income taxes.................................................... 5,286 786 278
Federal income tax provision.................................................. (2,281) (353) (365)
---------- ---------- ----------
Net income (loss).......................................................... $ 3,005 $ 433 $ (87)
========== ========== ==========
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
<PAGE>
PAGE F-4
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1997 1998 1999
---------- ---------- ----------
<S> <C> <C> <C>
Net income (loss)......................................................... $ 3,005 $ 433 $ (87)
---------- ---------- ----------
Other comprehensive income (loss), before income tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period............. 2,160 1,631 (3,633)
Less: Reclassification adjustment for gains included in
net income (loss)................................................ (790) (1,036) (57)
---------- ---------- ----------
Other comprehensive income (loss), before income tax...................... 1,370 595 (3,690)
Income tax benefit (provision) related to items of other
comprehensive income (loss)............................................ (466) (203) 1,255
---------- ---------- ----------
Other comprehensive income (loss), net of income tax...................... 904 392 (2,435)
---------- ---------- ----------
Comprehensive income (loss)............................................... $ 3,909 $ 825 $ (2,522)
========== ========== ==========
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
<PAGE>
PAGE F-5
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1997 1998 1999
---------- ---------- ----------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss)...................................................... $ 3,005 $ 433 $ (87)
Add (deduct):
Adjustments to reconcile net loss to cash provided by
(applied to) operating activities:
Realized investment gains, net................................... (790) (1,036) (57)
Net (gains) losses on sale of property and equipment............. 3 (137) 68
Amortization and depreciation.................................... 2,104 2,334 2,225
Provision for non-collection of premiums......................... 52 152 210
Provision for non-collection of reinsurance recoverables......... 527 50 -
Net change in non-cash balances relating to operating activities:
Premiums receivable.............................................. (1,246) (1,038) (19,459)
Reinsurance recoverable on paid losses........................... 596 (160) (672)
Reinsurance recoverable on unpaid losses......................... 2,859 (18,679) (8,522)
Reinsurance recoverable on unpaid losses from related parties.... 1,337 (1,997) 2,371
Prepaid reinsurance premiums..................................... (4,192) (12,786) 2,488
Prepaid reinsurance premiums to related parties.................. (1,332) (1,275) (2,436)
Deferred policy acquisition costs................................ (5) 3,475 (3,134)
Other assets..................................................... 25 (448) (871)
Unpaid losses and loss adjustment expenses....................... (4,392) 6,980 17,759
Unearned premiums................................................ 6,379 8,258 17,122
Policyholder deposits............................................ 814 106 199
Accrued taxes and other payables................................. 112 (1,956) 2,789
Premiums payable................................................. 2,440 6,456 (3,647)
Premiums payable to related parties.............................. (222) 980 (1,119)
---------- ---------- ----------
Cash provided by (applied to) operating activities............... 8,074 (10,288) 5,227
---------- ---------- ----------
INVESTING ACTIVITIES
Unrestricted fixed maturities available for sale:
Purchases........................................................... (32,518) (47,602) (21,844)
Sales............................................................... 18,674 36,177 4,159
Maturities.......................................................... 10,074 24,331 10,605
Unrestricted fixed maturities held to maturity:
Maturities.......................................................... 310 100 265
Equity securities available for sale:
Sales............................................................... 2,459 - -
Cost of property and equipment purchased............................... (884) (3,481) (3,912)
Proceeds from sale of property and equipment........................... 45 369 121
---------- ---------- ----------
Cash provided by (applied to) investing activities............... (1,840) 9,894 (10,606)
---------- ---------- ----------
FINANCING ACTIVITIES
Proceeds from notes payable & debentures............................... - 8,548 24,000
Payments on notes payable.............................................. (1,595) (1,934) (9,410)
Debt issue costs....................................................... - - (1,689)
Proceeds on borrowing from affiliate................................... 6,754 9,543 3,805
Payments on borrowing from affiliate................................... (7,802) (17,242) (15,491)
---------- ---------- ----------
Cash provided by (applied to) financing activities.................. (2,643) (1,085) 1,215
---------- ---------- ----------
Increase (decrease) in cash and cash equivalents during the period..... 3,591 (1,479) (4,164)
Cash and cash equivalents at beginning of period....................... 7,192 10,783 9,304
---------- ---------- ----------
Cash and cash equivalents at end of period............................. $ 10,783 $ 9,304 $ 5,140
========== ========== ==========
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
<PAGE>
PAGE F-6
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY
(Amounts in thousands)
<TABLE>
<CAPTION>
Accumulated
other Total
Common Paid-in Accumulated comprehensive shareholder's
stock surplus deficit income (loss) equity
---------- ---------- ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
Balance, January 1, 1997....... $ 2 $ 60,584 $ (15,478) $ (581) $ 44,527
Net income..................... - - 3,005 - 3,005
Change in unrealized gain on
investments available for
sale, net of income tax..... - - - 904 904
---------- ---------- ------------ ------------- -------------
Balance, December 31,1997...... 2 60,584 (12,473) 323 48,436
Net income..................... - - 433 - 433
Change in unrealized gain on
investments available for
sale, net of income tax...... - - - 392 392
---------- ---------- ------------ ------------- -------------
Balance, December 31, 1998.... 2 60,584 (12,040) 715 49,261
Net loss...................... - - (87) - (87)
Change in unrealized loss on
investments available for
sale, net of income tax...... - - - (2,435) (2,435)
---------- ---------- ------------ ------------- -------------
Balance, December 31, 1999..... $ 2 $ 60,584 $ (12,127) $ (1,720) $ 46,739
========== ========== ============ ============= =============
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
<PAGE>
PAGE F-7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1998 AND 1999
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, include property and
casualty insurance coverage primarily for businesses in various
industries, political subdivisions, surety bonds for small contractors
and group accident and health insurance in the United States of
America ("U.S."). A substantial part of the business is conducted
through individual independent insurance agencies and underwriting
managers, primarily in the Southwest and Midwest areas of the U.S.
One of Chandler USA's subsidiaries, LaGere and Walkingstick Insurance
Agency, Inc., operates as an independent insurance agency based in
Chandler, Oklahoma, and represents various insurance companies that
provide a variety of property and casualty, life and accident and
health coverages, and acts as a surplus lines broker specializing in
risk management and brokering insurance for commercial enterprises.
The Company is wholly owned by Chandler Insurance (Barbados), Ltd.
("Chandler Barbados") which, in turn, is wholly owned by Chandler
Insurance Company, Ltd. ("Chandler Insurance"), a Cayman Islands
company.
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. The following
represents the significant subsidiaries:
- National American Insurance Company ("NAICO").
- LaGere and Walkingstick Insurance Agency, Inc. ("L&W").
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, including the excess of cost over net assets
acquired, 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>
PAGE F-8
(E) 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.
(F) 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. Recoverability of such deferred costs is
dependent on the related unearned premiums on the policies being more
than expected claim losses. NAICO considers anticipated interest
income in determining if a premium deficiency exists. Due to NAICO's
purchase of additional reinsurance during 1998, NAICO's deferred
ceding commissions exceeded the deferred policy acquisition costs
related to direct and assumed business by approximately $80,000 at
December 31, 1998 and was recorded in accrued taxes and other
payables. Certain policy acquisition costs, such as policyholder
dividends, are expensed directly. NAICO expensed $1.2 million,
$242,000 and $324,000 during 1997, 1998 and 1999, respectively, for
dividends to policyholders primarily on participating workers
compensation policies. Gross written premiums for participating
policies were $3.6 million, $2.3 million and $1.9 million in 1997,
1998 and 1999, respectively.
(G) 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:
<TABLE>
<CAPTION>
1998 1999
---------- ----------
(In thousands)
<S> <C> <C>
Real estate and improvements............ $ 5,760 $ 8,151
Other property and equipment............ 10,142 11,230
--------- ----------
15,902 19,381
Accumulated depreciation................ (7,831) (8,662)
--------- ----------
$ 8,071 $ 10,719
========= ==========
</TABLE>
Depreciation expense was approximately $858,000, $1,047,000 and
$1,074,000 for 1997, 1998 and 1999, respectively.
(H) INTANGIBLE ASSETS
The cost of insurance licenses acquired is amortized over 40 years
using the straight-line method. The excess of cost over net assets
acquired is amortized by the straight-line method over 15-17 years.
Intangible assets included the following at December 31:
<TABLE>
<CAPTION>
1998 1999
---------- ----------
(In thousands)
<S> <C> <C>
Licenses................................... $ 5,991 $ 5,991
Excess of cost over net assets acquired.... 10,748 10,748
---------- ----------
16,739 16,739
Accumulated amortization................... (7,941) (8,739)
---------- ----------
$ 8,798 $ 8,000
========== ==========
</TABLE>
(I) POLICYHOLDER DEPOSITS
NAICO requires certain policyholders to pay a deposit at inception
of coverage to secure payment of future premiums and deductibles on
claims incurred. It is expressly agreed between NAICO and the
policyholder that the funds will be used by NAICO only in the event the
policyholder fails to pay any premiums, deductibles or other charges
when due. NAICO has established a liability for these deposits in an
amount equal to that due the policyholders based on insurance premiums
reported as of the balance sheet date.
<PAGE>
PAGE F-9
(J) 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 income tax as a 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.
(K) 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.
(L) 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.
(M) SUPPLEMENTAL CASH FLOW INFORMATION
Cash payments for interest and income taxes, and noncash investing
activities were as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1998 1999
---------- ---------- ----------
(In thousands)
<S> <C> <C> <C>
Cash payments during the year for:
Interest................................. $ 504 $ 941 $ 549
Income taxes............................. 1,855 170 857
Transfers from restricted securities, net... $ 1,597 $ 299 $ 892
</TABLE>
In January 1997, NAICO received publicly traded common stock valued
at approximately $2.2 million at the settlement date as a result of
settling certain legal disputes with a former underwriting manager for
a portion of the surety bond program.
During 1997, NAICO received shares of common stock with a fair value
of approximately $124,000 in connection with an unaffiliated entity's
conversion to a for-profit corporation.
During 1997, L&W acquired 494,617 shares of Chandler Insurance's
common stock from two former agents of NAICO and L&W as payment for
debts owed to NAICO and L&W. L&W transferred those shares during 1997
to Chandler Insurance Management, Ltd. ("CIM"), a wholly owned
subsidiary of Chandler Insurance who, in turn assumed debt of L&W to
Chandler Barbados in the amount of approximately $2.5 million, the
fair value of the shares.
<PAGE>
PAGE F-10
(N) 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 11, 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.
(O) ACCOUNTING STANDARD ISSUED BUT NOT YET ADOPTED
In June 1998, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 133,
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. SFAS
No. 133 establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. It requires that Chandler USA
recognize all derivatives as either assets or liabilities in the
statement of financial condition and measure those instruments at fair
value. The accounting for changes in the fair value of a derivative
depends on the intended use of the derivative and the resulting
designation. Chandler USA will adopt SFAS No. 133 when required.
Management of Chandler USA does not expect that adoption of SFAS No.
133 will have a material impact on Chandler USA's consolidated
financial condition or results of operations.
NOTE 2. INVESTMENTS AND INTEREST INCOME
Net interest income and realized investment gains are summarized in the
following table. These amounts are net of investment expenses.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1998 1999
---------- ---------- ----------
(In thousands)
<S> <C> <C> <C>
Interest on fixed-maturity investments............. $ 5,888 $ 4,963 $ 4,631
Interest on cash equivalents....................... 598 622 501
Investment expenses................................ (356) (681) (1,173)
---------- ---------- ----------
Interest income, net............................ 6,130 4,904 3,959
---------- ---------- ----------
Realized gains - fixed-maturity investments, net... 487 1,036 57
Realized gains - equities, net..................... 303 - -
---------- ---------- ----------
Realized investment gains, net.................. 790 1,036 57
---------- ---------- ----------
$ 6,920 $ 5,940 $ 4,016
========== ========== ==========
</TABLE>
Investment expenses include $72,000, $399,000 and $851,000 for the
years ended December 31, 1997, 1998 and 1999, respectively, in expense to
subsidize a premium finance program for certain insureds of NAICO with an
unaffiliated premium finance company.
<PAGE>
PAGE F-11
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:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED FAIR CARRYING
DECEMBER 31, 1998 COST GAINS LOSSES VALUE VALUE
- ----------------------------------------- ---------- ---------- ---------- ---------- ----------
(In thousands)
<S> <C> <C> <C> <C> <C>
FIXED MATURITIES AVAILABLE FOR SALE:
U.S. Treasury securities and obligations
of U.S. government corporations
and agencies.......................... $ 39,650 $ 233 $ (58) $ 39,825 $ 39,825
Debt securities issued by
foreign governments................... 1,510 9 - 1,519 1,519
Obligations of states and political
subdivisions.......................... 12,178 318 - 12,496 12,496
Corporate obligations.................... 23,092 289 (45) 23,336 23,336
Public utilities......................... 6,221 141 (18) 6,344 6,344
Mortgage-backed securities............... 725 24 - 749 749
---------- ---------- ---------- ---------- ----------
$ 83,376 $ 1,014 $ (121) $ 84,269 $ 84,269
========== ========== ========== ========== ==========
FIXED MATURITIES HELD TO MATURITY:
U.S. Treasury securities and obligations
of U.S. government corporations
and agencies.......................... $ 1,183 $ 149 $ - $ 1,332 $ 1,183
========== ========== ========== ========== ==========
EQUITY SECURITIES AVAILABLE FOR SALE:
Corporate stock.......................... $ - $ 191 $ - $ 191 $ 191
========== ========== ========== ========== ==========
<CAPTION>
DECEMBER 31, 1999
- -----------------------------------------
<S> <C> <C> <C> <C> <C>
FIXED MATURITIES AVAILABLE FOR SALE:
U.S. Treasury securities and obligations
of U.S. government corporations
and agencies.......................... $ 42,677 $ 7 $ (1,194) $ 41,490 $ 41,490
Debt securities issued by
foreign governments................... 1,503 - (5) 1,498 1,498
Obligations of states and political
subdivisions.......................... 10,188 - (274) 9,914 9 914
Corporate obligations.................... 28,963 - (1,055) 27,908 27,908
Public utilities......................... 6,194 - (402) 5,792 5,792
Mortgage-backed securities............... 624 12 (2) 634 634
---------- ---------- ---------- ---------- ----------
$ 90,149 $ 19 $ (2,932) $ 87,236 $ 87,236
========== ========== ========== ========== ==========
FIXED MATURITIES HELD TO MATURITY:
U.S. Treasury securities and obligations
of U.S. government corporations
and agencies.......................... $ 984 $ 55 $ - $ 1,039 $ 984
========== ========== ========== ========== ==========
EQUITY SECURITIES AVAILABLE FOR SALE:
Corporate stock.......................... $ - $ 306 $ - $ 306 $ 306
========== ========== ========== ========== ==========
</TABLE>
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, 1999 are shown below:
<TABLE>
<CAPTION>
AVAILABLE FOR SALE HELD TO MATURITY
--------------------- ---------------------
AMORTIZED AMORTIZED
COST FAIR VALUE COST FAIR VALUE
---------- ---------- ---------- ----------
(In thousands)
<S> <C> <C> <C> <C>
Due in one year or less.................... $ 22,728 $ 22,622 $ - $ -
Due after one year through five years...... 33,344 32,676 984 1,039
Due after five years through ten years..... 33,453 31,304 - -
Due after ten years........................ - - - -
---------- ---------- ---------- ----------
89,525 86,602 984 1,039
Mortgage-backed securities................. 624 634 - -
---------- ---------- ---------- ----------
$ 90,149 $ 87,236 $ 984 $ 1,039
========== ========== ========== ==========
</TABLE>
<PAGE>
PAGE F-12
Realized gains and losses from sales of fixed maturities and equity
securities are shown below:
<TABLE>
<CAPTION>
GROSS REALIZED GAINS GROSS REALIZED LOSSES
-------------------- ---------------------
(In thousands)
<S> <C> <C>
1997.............................. $ 829 $ 39
1998.............................. 1,081 45
1999.............................. 63 6
</TABLE>
NAICO is required by several states to deposit securities with state
regulators as a condition of doing business in those states. As of December
31, 1998 and 1999, the carrying value of these deposits totaled approximately
$8.2 million and $7.2 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 $4.3 million
and $3.2 million at December 31, 1998 and 1999, 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.
The following table sets forth a reconciliation of the beginning and
ending unpaid losses and loss adjustment expenses which are net of
reinsurance deductions.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1998 1999
---------- ---------- ----------
(In thousands)
<S> <C> <C> <C>
Net balance before provision for uncollectible reinsurance
at beginning of year................................................ $ 53,313 $ 53,345 $ 39,570
---------- ---------- ----------
Net losses and loss adjustment expenses incurred related to:
Current year........................................................ 46,645 34,313 65,139
Prior years......................................................... 1,868 1,737 3,520
---------- ---------- ----------
Total............................................................ 48,513 36,050 68,659
---------- ---------- ----------
Net paid losses and loss adjustment expenses related to:
Current year........................................................ (19,909) (19,495) (33,210)
Prior years......................................................... (28,572) (30,330) (23,896)
---------- ---------- ----------
Total............................................................ (48,481) (49,825) (57,106)
---------- ---------- ----------
Balance before provision for uncollectible reinsurance at end of year.. 53,345 39,570 51,123
Adjustments to reinsurance recoverables on
unpaid losses for uncollectible reinsurance......................... 690 351 255
---------- ---------- ----------
Net balance at end of year............................................. $ 54,035 $ 39,921 $ 51,378
========== ========== ==========
</TABLE>
<PAGE>
PAGE F-13
NAICO does not ordinarily insure against environmental matters as that
term is commonly used. However, in some cases, regulatory filings made by
NAICO on behalf of an insured can make NAICO directly liable to the regulatory
authority for property damage which could include environmental pollution. In
those cases, NAICO ordinarily has recourse against the insured or the surety
bond principal for amounts paid. NAICO has insured certain trucking companies
and pest control operators that are required to provide proof of insurance
which in some cases assures payment for clean-up and remediation of damage
resulting from sudden and accidental release or discharge of contaminants or
other substances which may be classified as pollutants. NAICO also provides
surety bonds for construction contractors that use or have control of such
substances and for contractors that remove and dispose of asbestos as a
part of their contractual obligations. NAICO also insures independent oil and
gas producers that may purchase coverage for the escape of oil, saltwater, or
other substances which may be harmful to persons or property, but may not
generally be classified as pollutants. NAICO maintains claims records which
segregate this type of risk for the purpose of evaluating environmental risk
exposure. Based upon the nature of such lines of business with insureds of
NAICO, and current data regarding the limited severity and infrequency of
such matters, it appears that potential environmental risks are not a
significant portion of claims reserves and therefore would not likely have a
material impact, if any, on the consolidated financial condition, results of
operations or cash flows of Chandler USA.
NOTE 4. NOTES PAYABLE
During 1996, Chandler USA borrowed $4.5 million from a bank for a three
year term. During the fourth quarter of 1997, the related loan agreement was
amended to provide for additional borrowings up to $8.5 million and to revise
the term to five years with interest payable at a floating rate equal to 1%
over the prime rate published in the Wall Street Journal. The principal
balance of the note was approximately $7,397,000 at December 31, 1998.
Proceeds from the note were used to repay amounts due to Chandler Barbados.
The bank note was collateralized by the shares of NAICO stock owned by
Chandler USA. In July 1999, the note was repaid from the proceeds of a
debenture offering. See Note 5.
At December 31, 1998, Chandler USA had a note payable related to the
acquisition of Network Administrators, Inc., an inactive subsidiary of
Chandler USA, with a balance of $75,000. The note had an interest rate of
7% per annum and was repaid during 1999.
In February 1998, Chandler USA entered into a five year loan agreement
with a bank having a principal amount of $2.3 million and an interest rate
of 7.75% per annum. Effective September 28, 1998, the interest rate was
reduced to 7.5% per annum. The outstanding balance of the note was
approximately $1,938,000 at December 31, 1998. The loan was collateralized
by certain equipment which was purchased with the proceeds of the loan. The
equipment had previously been leased by Chandler USA. In July, 1999, the
note was repaid from the proceeds of a debenture offering. See Note 5.
NOTE 5. DEBENTURE OFFERING
On July 16, 1999, Chandler USA completed a public offering of $24
million principal amount of senior 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 proceeds to Chandler USA before expenses but after
the underwriter's discount were $23.16 million. The proceeds of the offering
were used to repay existing bank debt, to repay amounts owed by Chandler USA
to its parent, Chandler Barbados, and for general corporate purposes.
Chandler USA has capitalized $1.7 million related to debt issuance costs for
the debentures. These costs are being amortized as interest expense over the
term of the debentures. 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, mergers, consolidations and sales of
assets. At December 31, 1999, Chandler USA was in compliance with all
covenants.
NOTE 6. SHAREHOLDER'S EQUITY
CAPITAL STOCK
In addition to the regulatory oversight of NAICO by the Nebraska
Department of Insurance, Chandler Insurance and Chandler USA are also subject
to regulation under the Nebraska Insurance Holding Company Systems Act (the
"Holding Company Act"). In addition to various reporting requirements
imposed on Chandler Insurance and Chandler USA, the Holding Company Act
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 Nebraska Department of Insurance
regarding their proposed ownership of such shares.
<PAGE>
PAGE F-14
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:
<TABLE>
<CAPTION>
1997 1998 1999
---------- ---------- ----------
(In thousands)
<S> <C> <C> <C>
Statutory net income (loss)..... $ 6,737 $ 6,877 $ (1,455)
Statutory capital and surplus... $ 45,283 $ 45,327 $ 44,638
</TABLE>
The National Association of Insurance Commissioners 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, 1998 and 1999.
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 Nebraska Department of
Insurance is generally limited to the greater of (i) statutory net income
excluding realized capital gains for the preceding year (statutory net
income excluding realized capital gains from the second and third preceding
years, less any dividends paid, may be carried forward), 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 2000 without
the approval of the Nebraska Department of Insurance is approximately $4.9
million. Prior to 1998, NAICO (during the ownership by Chandler USA) had not
paid any cash shareholder dividends. During 1998, NAICO paid a cash
shareholder dividend of $6.0 million to Chandler USA. In January 2000, NAICO
paid a cash shareholder dividend of $1,250,000 to Chandler USA.
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 $11.9 million
as of December 31, 1999). NAICO paid approximately $423,000, $561,000 and
$465,000 in policyholder dividends during 1997, 1998 and 1999, respectively.
NOTE 7. 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:
<TABLE>
<CAPTION>
1997 1998 1999
------------ ------------- ------------
(In thousands)
<S> <C> <C> <C>
Computed income tax provision at 34%................. $ 1,797 $ 267 $ 95
Increase (decrease) in income taxes resulting from:
Amortization of licenses and other intangibles.... 380 362 271
Interest income on tax exempt securities.......... (32) (298) (140)
Other, net........................................ 136 22 139
------------ ------------- ------------
Federal income tax provision......................... $ 2,281 $ 353 $ 365
============ ============= ============
</TABLE>
U.S. Federal income tax provision (benefit) consists of:
<TABLE>
<CAPTION>
CURRENT DEFERRED TOTAL
------------ -------------- ------------
(In thousands)
<S> <C> <C> <C>
1997................................................. $ 2,389 $ (108) $ 2,281
1998................................................. 52 301 353
1999................................................. 1,127 (762) 365
</TABLE>
<PAGE>
PAGE F-15
Deferred income tax provision (benefit) relating to temporary differences
includes the following components:
<TABLE>
<CAPTION>
1997 1998 1999
---------- ---------- ----------
(In thousands)
<S> <C> <C> <C>
Loss reserve discounts...................................... $ (97) $ 921 $ (500)
Unearned premiums........................................... (58) 395 (1,168)
Deferred policy acquisition costs........................... 1 (1,209) 1,093
Reserve for uncollectible premiums receivable
and reinsurance recoverables............................. 188 (9) (63)
Depreciation and lease expense.............................. (164) (60) (46)
Other....................................................... 22 263 (78)
---------- ---------- ----------
$ (108) $ 301 $ (762)
========== ========== ===========
</TABLE>
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:
<TABLE>
<CAPTION>
1998 1999
---------- ----------
(In thousands)
<S> <C> <C>
Deferred tax assets:
Loss reserve discounts...................................................... $ 2,832 $ 3,410
Unearned premiums........................................................... 1,430 2,598
Reserve for uncollectible premiums receivable and reinsurance recoverables.. 180 243
Unrealized loss on investments available for sale........................... - 886
Net operating loss carryforwards - state.................................... 1,670 1,774
Other....................................................................... 253 263
Valuation allowance......................................................... (1,670) (1,774)
---------- ----------
Total deferred tax assets...................................................... 4,695 7,400
---------- ----------
Deferred tax liabilities:
Deferred policy acquisition costs........................................... (27) 1,066
Depreciation and lease expense.............................................. 693 646
Unrealized gain on investments available for sale........................... 368 -
Other....................................................................... 590 601
---------- ----------
Total deferred tax liabilities................................................. 1,624 2,313
---------- ----------
Net deferred tax assets........................................................ $ 3,071 $ 5,087
========== ==========
</TABLE>
At December 31, 1999, Chandler USA had net operating loss carryforwards
available for Oklahoma state tax purposes totaling approximately $29.6
million which expire in the years 2006 through 2015. A valuation allowance
has been provided for the tax effect of the state net operating loss
carryforwards since realization of such amounts is not considered more likely
than not.
NOTE 8. 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 15% of compensation, not to exceed the statutory limitations
which for 1999 was $10,000. 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 $3,600 per
employee per year. In addition, Chandler USA may make additional annual
contributions to the 401(k) plan at its discretion. Chandler USA's expense
for 401(k) plan contributions was $254,000, $259,000 and $276,000 for 1997,
1998 and 1999, respectively.
NOTE 9. 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.
<PAGE>
PAGE F-16
A number of Chandler USA's significant assets (including deferred policy
acquisition costs, property and equipment, reinsurance recoverables, prepaid
reinsurance premiums, licenses and excess of cost over net assets acquired)
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, notes payable and
premiums payable, approximates their fair value as of December 31, 1998 and
1999. The estimated fair values of Chandler USA's fixed-maturity and equity
security investments are disclosed at Note 2. At December 31, 1999, Chandler
USA maintained custody of letters of credit from policyholders totaling $12.3
million, which is a reasonable estimate of their fair value.
NOTE 10. LITIGATION
Chandler Insurance and certain of its subsidiaries and affiliates,
including Chandler USA, have been involved in various matters of litigation
with CenTra, Inc. ("CenTra") and certain of its affiliates, officers and
directors (the "CenTra Group") since 1992. The CenTra Group has been a
significant shareholder in Chandler Insurance owning 49.2% of Chandler
Insurance's stock in July 1992. Three present or former executive officers
of CenTra, Norman E. Harned, Ronald W. Lech and M. J. Moroun were directors
of Chandler Insurance until November 1999.
On March 25, 1997, the U.S. District Court for the District of Nebraska
("Nebraska Court") ordered CenTra and certain of its affiliates to divest
all Chandler Insurance shares owned by them. The CenTra defendants owned or
controlled 3,133,450 Chandler Insurance shares. The Nebraska Court approved
a divestiture plan submitted by NAICO (the "NAICO Plan") which called for
Chandler Insurance to acquire and cancel the shares of Chandler Insurance
stock owned by the CenTra Group. During December 1999, Chandler Insurance
acquired 1,989,200 shares of its stock in exchange for payment of
$15,204,758. These shares were canceled upon acquisition by Chandler
Insurance. The Nebraska Court continues to hold 1,142,625 shares pending
the outcome of CenTra's appeal of a judgment by the U.S. District Court in
Oklahoma City, Oklahoma ("Oklahoma Court") regarding these shares. Following
the conclusion of the appeal, the Nebraska Court will determine the method of
divestiture of these shares. Chandler Insurance cannot predict when the
appellate court will rule on the appeal.
On April 1, 1997, the Oklahoma Court entered judgment in favor of NAICO
on CenTra's claims for alleged wrongful cancellation of CenTra's insurance
with NAICO and its affiliate NAICO Indemnity (Cayman), Ltd. ("NAICO
Indemnity") in 1992. The remaining issues were submitted to a jury. On
April 22, 1997, the Oklahoma Court entered judgments on the jury verdicts.
One judgment against Chandler Insurance required the CenTra Group to return
stock it purchased in 1990 to Chandler Insurance in return for a payment of
$5,099,133 from Chandler Insurance. Payment was made and the stock was
returned to Chandler Insurance and canceled in December 1999 as a part of
the acquisition of shares described previously. Another judgment was against
both Chandler Insurance and Chandler Barbados. CenTra and an affiliate,
Ammex, Inc., were awarded $6,882,500 in connection with a 1988 stock purchase
agreement. On March 10, 1998, the Oklahoma Court modified its judgment to
require CenTra and its affiliates to deliver 1,142,625 shares of Chandler
Insurance stock they owned upon payment of the $6,882,500 judgment which was
entered in April 1997. Both of these judgments related to an alleged failure
by Chandler Insurance to adequately disclose the fact that ownership of
Chandler Insurance's stock may be subject to regulation by the Nebraska
Department of Insurance under certain circumstances.
Judgment was also entered in favor of CenTra and against certain
officers and/or directors of Chandler Insurance on the securities claims
relating to CenTra's 1990 stock purchases and the failure to disclose the
application of Nebraska insurance law, but the judgments were $1 against each
individual defendant on those claims. On ten derivative claims brought by
CenTra, the jury found in CenTra's favor on three. Certain officers were
directed to repay to Chandler USA bonuses received for the years 1988 and
1989 totaling $711,629 and a total of $25,000 for personal use of corporate
aircraft. These amounts are included in other assets in the accompanying
consolidated balance sheets. On the remaining claim relating to the
acquisition of certain insurance agencies in 1988, the jury awarded $1 each
against six officers and/or directors.
Judgment was also entered in favor of NAICO and NAICO Indemnity on
counterclaims against CenTra for CenTra's failure to pay insurance premiums.
Judgment was for the amount of $788,625. During 1998, the judgment was
paid by funds held by the Oklahoma Court aggregating, with interest,
$820,185. DuraRock Underwriters, Ltd. ("DuraRock"), an affiliate of CenTra,
claimed $725,000 was owed to it under certain reinsurance treaties. That
claim was settled in January 2000 with NAICO paying $52,617 and NAICO
Indemnity paying $84,883 to DuraRock.
The Oklahoma Court's judgment also upheld a resolution adopted by
Chandler Insurance's Board of Directors in August 1992 pursuant to Article
XI of Chandler Insurance's Articles of Association preventing CenTra and its
affiliates from voting their Chandler Insurance stock.
<PAGE>
PAGE F-17
As a result of the Oklahoma Court judgments and subsequent decisions,
Chandler Insurance recorded a net charge for the litigation matters during
1997 totaling approximately $1.4 million ($1.6 million including provision
for federal income tax). Chandler Insurance recorded the return of
1,660,125 shares of Chandler Insurance's stock in connection with the
rescission judgments as a decrease to shareholders' equity in the amount of
approximately $12.0 million. On April 21, 1998, the Oklahoma Court denied
the CenTra Group's request for costs and attorney fees. The CenTra Group did
not appeal this decision within the time permitted by applicable law.
Accordingly, Chandler Insurance reduced the previous 1997 net charge for
litigation matters by $3.8 million during the second quarter of 1998.
On March 23, 1998, the CenTra Group filed a formal notice of intent to
appeal certain orders of the Oklahoma Court, and filed the initial appellate
brief on September 9, 1998. The appeals are being considered by the U.S.
Court of Appeals for the 10th Circuit. The CenTra Group's appeals are based
upon the Oklahoma Court's failure to award prejudgment interest, the Oklahoma
Court's refusal to permit the CenTra Group to amend certain pleadings to
assert new claims, the Oklahoma Court's modification of the judgment for
$6,882,500 to require CenTra to return shares of Chandler Insurance's stock
upon payment of the judgment, and the Oklahoma Court's denial of attorney
fees. Chandler Insurance believes the appeal of this issue is untimely and
therefore barred by law. Chandler Insurance elected not to appeal any of
the judgments. The individual officers and directors against whom judgments
were entered have all filed appeals.
Chandler Insurance's board of directors appointed a committee of the
board (the "Committee") to deal with all matters arising from the Oklahoma
litigation. The members of the Committee are Messrs. Jacoby, Maestri and
Davis, all of whom are non-parties to the CenTra litigation. The Committee
is empowered by the board to make decisions on behalf of Chandler Insurance
regarding issues relating to litigation strategy, officer and director
indemnification and claims made under Chandler Insurance's director and
officer liability insurance policy (the "D&O Insurer"). A similar
committee composed of Chandler USA directors is authorized to deal with
those same issues regarding Chandler USA.
In 1997, NAICO learned that several CenTra affiliates had filed two
lawsuits against NAICO, NAICO Indemnity and certain NAICO officers
asserting some of the same claims made and tried in the Oklahoma lawsuit
described previously. Those claims were purportedly prosecuted by CenTra
on its own behalf and on behalf of its subsidiaries and were based upon
alleged wrongful cancellation of their insurance policies by NAICO and NAICO
Indemnity. The Oklahoma Court entered a judgment against CenTra on these
claims. NAICO and NAICO Indemnity contend that the Oklahoma Court's
adjudication is conclusive as to all claims. The lawsuits have been
consolidated and have been assigned to the same judge who presided over the
action in the Oklahoma Court. Dispositive motions filed by NAICO, NAICO
Indemnity and the other defendants are currently under consideration by the
Oklahoma Court.
In the CenTra litigation, certain officers and directors of Chandler
USA and Chandler Insurance were named as defendants. 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. Chandler Barbados has paid expenses on behalf of these
officers and directors totaling approximately $2.3 million as of December
31, 1999. A portion of these expenses relate to claims which have been
dismissed or which were decided in favor of the officers and directors.
These expenses together with certain other expenses may be recovered from 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 is included in other assets in Chandler Barbados' and Chandler
USA's balance sheets. Chandler Insurance and its subsidiaries are entitled
to a total of $5 million under the applicable insurance policy to the extent
they have advanced reimbursable expenses. Chandler Insurance is negotiating
with the insurer for payment of the policy balance. Chandler Insurance and
its subsidiaries could recover the remaining policy limits or could
compromise their claim, and could incur significant costs in either case.
The ultimate outcome of the appeals of the various parties as described
above could have a material adverse effect on Chandler USA and Chandler
Insurance and could negatively impact future earnings. Chandler USA's
management believes that adequate financial resources are available to pay
the judgments as they currently exist or as they may be modified on appeal.
As a holding company, Chandler USA may receive cash through equity sales,
borrowings and dividends from its subsidiaries. Chandler Barbados and NAICO
are subject to various regulations which restrict their ability to pay
shareholder dividends. A reduction in the amount of invested assets, or an
increase in borrowings resulting from potential payments of these judgments
would reduce investment earnings or increase operating expenses in future
periods.
<PAGE>
PAGE F-18
At the present time Chandler USA and its affiliates are actively
participating in court proceedings and rights of appeal concerning these
legal proceedings; therefore, Chandler USA and its affiliates are unable to
predict the outcome of such litigation with certainty or the effect of such
ongoing litigation on future operations. Chandler USA and its affiliates are
also unable to predict the effect of the remaining divestiture order on the
rights, limitations or other regulation of ownership of the stock of any
existing or prospective holders of Chandler Insurance's common stock, or the
effect on the market price of Chandler Insurance's stock.
OTHER LITIGATION
Chandler USA and its subsidiaries are not parties to any other material
litigation other than as is routinely encountered in their respective
business activities.
NOTE 11. 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 policy.
NAICO has structured separate reinsurance programs for construction
surety bonds, property, workers compensation, casualty (including
automobile liability and physical damage, general liability, umbrella
liability and related professional liability) and group accident and
health. Chandler Barbados reinsures NAICO for a portion of the risk on
the construction surety bonds, workers compensation and casualty reinsurance
programs.
In July 1997, NAICO purchased additional reinsurance for the California
portion of the nonstandard private-passenger automobile program. During the
first quarter of 1998, NAICO purchased additional reinsurance under its
workers compensation and casualty reinsurance programs that substantially
reduced the combined net retentions in these lines of business. During the
second quarter of 1998, NAICO purchased additional reinsurance under its
construction surety bond reinsurance program. The purchase of the
additional reinsurance coverages in 1997 and 1998 substantially reduced the
per occurrence retention for NAICO's workers compensation, casualty, surety
bond and private-passenger automobile lines of business, but resulted in
significantly lower net premiums earned, losses and loss adjustment expenses
and policy acquisition costs. The purchase of additional reinsurance also
resulted in an increase in reinsurance recoverables on unpaid losses,
prepaid reinsurance premiums and premiums payable and a decrease in deferred
policy acquisition costs. During the fourth quarter of 1999, NAICO agreed
to rescind reinsurance treaties which covered a portion of its workers
compensation business and which had been in effect since January 1, 1999.
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 retention levels. A
majority of NAICO's reinsurance programs renew on January 1, April 1 or
July 1 of each year. NAICO renewed all January 1, 2000 reinsurance
programs. At the present time, NAICO expects to renew the reinsurance
programs that renew on April 1 and July 1, 2000.
In formulating its reinsurance programs, NAICO considers numerous
factors, the most important of which are the financial stability of the
reinsurer, including its ability to provide sufficient collateral if
required, reinsurance coverage offered and price.
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, which resulted in an increase in net premiums earned of $918,000
and $931,000 in 1997 and 1998, respectively, and a decrease in net premiums
earned of $877,000 in 1999.
<PAGE>
PAGE F-19
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 owed NAICO
approximately $1.3 million for reinsurance recoverables on paid losses and
loss adjustment expenses as of December 31, 1999. NAICO is seeking
arbitration in order to enforce the terms of the reinsurance treaties.
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, allowances are established for
amounts deemed uncollectible. NAICO charged $527,000 and $50,000 to policy
acquisition costs during 1997 and 1998, respectively, for estimated
uncollectible reinsurance recoverables from certain unaffiliated reinsurers.
NAICO did not incur any charges for uncollectible reinsurance recoverables
from unaffiliated reinsurers in 1999.
The effect of reinsurance on premiums written and earned was as follows:
<TABLE>
<CAPTION>
1997 1998 1999
-------------------- -------------------- --------------------
WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED
--------- --------- --------- --------- --------- ---------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Direct........................... $123,014 $116,101 $134,436 $126,017 $169,449 $152,314
Assumed.......................... 74 608 (143) 17 120 133
Ceded............................ (41,531) (36,007) (87,671) (73,610) (65,297) (65,349)
--------- --------- --------- --------- --------- ---------
Net premiums..................... $ 81,557 $ 80,702 $ 46,622 $ 52,424 $104,272 $ 87,098
========= ========= ========= ========= ========= =========
</TABLE>
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 $18.0 million,
$54.9 million and $70.4 million for 1997, 1998 and 1999, 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, 1998 and 1999 were $28.5 million and $47.7 million,
respectively. The 1999 amount includes $12.9 million related to the
rescission of the reinsurance treaties. This amount was collected in
January 2000. Receivables for deductibles, in most cases, are secured by
cash deposits and letters of credit. At December 31, 1999, NAICO maintained
custody of such letters of credit securing these and other transactions
totaling approximately $12.3 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 1997, 1998 or 1999.
NAICO's largest underwriting manager was responsible for underwriting
$12.3 million and $4.0 million of NAICO's direct written and assumed premiums
for the California and Arizona portions of the nonstandard private-passenger
automobile program in 1997 and 1998, respectively. The program underwritten
by this underwriting manager was discontinued in 1998. NAICO's bail bond
underwriting manager was responsible for gross written premiums of $2.6
million, $2.8 million and $2.8 million during 1997, 1998 and 1999,
respectively.
Approximately $8.7 million, or 14% of NAICO's reinsurance recoverables
and prepaid reinsurance premiums at December 31, 1999 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>
PAGE F-20
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, 1999.
<TABLE>
<CAPTION>
CEDED REINSURANCE
NET PREMIUMS FOR A.M.
REINSURANCE THE YEAR ENDED BEST CO.
NAME OF REINSURER RECOVERABLE (1) DECEMBER 31, 1999 RATING
- -------------------------------------------------------- --------------- ----------------- --------
(Dollars in thousands)
<S> <C> <C> <C>
Chandler Barbados....................................... $ 19,145 $ 23,599 -(3)
First Excess and Reinsurance Corporation................ 16,528 10,709 A
Swiss Reinsurance America Corporation................... 10,801 12,909 A+
SCOR Reinsurance Company................................ 8,544 9,479 A+
Reliance Insurance Company (2).......................... 5,253 (5,484) A-
--------------- -----------------
Top five reinsurers.................................. $ 60,271 $ 51,212
=============== =================
All reinsurers....................................... $ 79,927 $ 65,297
=============== =================
Percentage of total represented by top five reinsurers.. 75% 78%
- --------------------------------------------------------
<FN>
(1) Includes losses and loss adjustment expenses paid and outstanding,
unpaid losses and loss adjustment expenses and prepaid reinsurance
premiums recoverable from reinsurers as of December 31, 1999.
(2) Excludes premiums receivable of $12.9 million as of December 31, 1999
related to the rescission of two reinsurance treaties. NAICO collected
this amount during January 2000.
(3) Chandler Barbados owns 100% of the common stock of Chandler USA, which in
turn owns 100% of the common stock of NAICO. Although Chandler Barbados
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, 1999, Chandler Barbados had cash and
investments with a fair value of $24.1 million deposited in a trust
account for the benefit of NAICO.
</TABLE>
NAICO loaned funds to certain agents which are secured by the agent's
stock in a Cayman Islands based reinsurance company. The outstanding loan
balances at December 31, 1999 consist of 21 individual loans totaling
approximately $650,000 ($977,000 at December 31, 1998) and are included in
other assets in the accompanying consolidated balance sheets.
OTHER
See Note 10 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 Insurance 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 to participate in certain incentive bonus plans
offered by Chandler USA and its subsidiaries.
Chandler USA has an employment agreement with Brenda B. Watson, a
director and executive officer of Chandler Insurance and L&W, and an
executive officer of NAICO. Under this agreement, Ms. Watson's base
compensation is established at not less than $125,000 per year. The
agreement terminates on December 31, 2003, unless earlier terminated by
Chandler USA for cause, as defined in the agreement. In the event that
Ms. Watson is terminated without cause, she is entitled to receive her base
compensation through the termination date. In addition to her base
compensation, Ms. Watson is eligible to receive certain benefits and to
participate in certain incentive bonus plans offered by Chandler USA and its
subsidiaries.
In addition, certain executives are eligible to participate in bonus
plans based upon premium production and/or profitability.
<PAGE>
PAGE F-21
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 $851,000 and $667,000 at December 31, 1998 and 1999,
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 $54,000 and $67,000 at December 31, 1998 and 1999,
respectively.
At December 31, 1999, Chandler USA's subsidiaries were committed under
noncancellable operating leases for certain equipment and office space.
Rental payments under these leases were $1.1 million, $503,000 and $454,000
in 1997, 1998 and 1999, respectively. Future minimum lease payments are as
follows:
<TABLE>
<CAPTION>
(In thousands)
<S> <C>
2000.............. $ 376
2001.............. 266
2002.............. 143
2003.............. 91
2004.............. -
--------------
$ 876
==============
</TABLE>
NOTE 12. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
NAICO and NAICO Indemnity provided insurance coverage and risk management
services for CenTra and certain of its affiliates (see Note 10). All such
policies were canceled effective September 5, 1992 or expired as of
September 30, 1992. As of December 31, 1997, the unpaid premiums and other
amounts due from CenTra to the Company's subsidiaries were $788,625, as
reflected by the April 22, 1997 jury verdicts. Chandler USA's subsidiaries
had recorded a receivable of $302,000 related to the judgment. During 1998,
the judgment was paid by funds held by the Oklahoma Court aggregating, with
interest, $820,185. Chandler USA's subsidiaries received $313,862 of the
funds paid by the Oklahoma Court. DuraRock, a CenTra affiliate, claimed
$725,000 was owed to it by NAICO and NAICO Indemnity under certain
reinsurance treaties. In January 2000, the parties agreed to settle the
matter and NAICO and NAICO Indemnity agreed to pay DuraRock a total of
$137,500, which was recorded in the fourth quarter of 1999. NAICO recorded
$52,617 in litigation expenses in the fourth quarter of 1999 for the
settlement. Liberty Bell Agency, Inc. ("Liberty Bell"), an affiliate of
CenTra, has administered claims under the CenTra insurance program. NAICO and
NAICO Indemnity reimburse Liberty Bell for their share of claim payments, but
are not obligated for DuraRock's share.
DuraRock reinsured NAICO and NAICO Indemnity for substantially all
CenTra risks underwritten by them. As a part of a settlement of certain
related litigation, National Union Fire Insurance Company of Pittsburgh
("National Union") agreed to assume the reinsurance obligations of DuraRock
effective March 31, 1993. Reinsurance recoverables from National Union
totaled approximately $1.5 million and $755,000 as of December 31, 1998 and
1999, respectively. The reduction in reinsurance recoverables as well as to
the corresponding liabilities for unpaid losses and loss adjustment expenses
is based upon information provided by Liberty Bell and National Union.
Although NAICO's and NAICO Indemnity's risks are fully reinsured, they are
ultimately liable as the policy-issuing company. If National Union does not
meet its obligations, such failure could adversely affect NAICO and Chandler
USA (see Notes 10 and 11).
OTHER
Chandler USA leases and has made certain improvements to a rural
property in which certain directors and/or officers of Chandler USA own
interests. Under the lease, no cash rental is paid, but a subsidiary of
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 $159,000, $217,000 and
$202,000 in expenses associated with its use of this property during 1997,
1998 and 1999, respectively, including $9,000, $7,000 and $8,000 paid to
Davenport Farms for reimbursement of certain expenses, such as utility and
similar expenses, for the years 1997, 1998 and 1999, respectively.
<PAGE>
PAGE F-22
NOTE 13. SEGMENT INFORMATION
Chandler USA has two reportable operating segments: property and
casualty insurance and agency. The segments are managed separately due to
the differences in the nature of the insurance products and services sold.
The property and casualty segment accounted for 90.6%, 87.1% and 91.3%
of 1997, 1998 and 1999 consolidated revenues before intersegment
eliminations, respectively. The insurance products are underwritten by NAICO
and are marketed through independent insurance agencies, including L&W.
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 55%, 55%
and 48% of gross written premiums in 1997, 1998 and 1999, respectively, while
Texas accounted for approximately 18%, 28% and 37% 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.
The agency segment accounted for 9.4%, 12.9% and 8.7% of 1997, 1998 and
1999 consolidated revenues before intersegment eliminations, respectively.
L&W is appointed by insurers to solicit applications for policies of
insurance, primarily in Oklahoma. L&W represents personal and commercial
lines insurance companies, and markets property and casualty, individual and
group life, medical and disability income coverages. Major target classes of
business are political subdivisions, healthcare facilities, transportation
companies, manufacturers, contractors, oil & gas, retailers, wholesalers and
service organizations. A large portion of certain classes of business
produced by L&W is placed with NAICO. L&W also acts as a surplus lines
broker specializing in risk management and brokering insurance for commercial
enterprises. L&W acts as the underwriter for a significant portion of
NAICO's construction surety bond program. L&W places direct agency business
as well as business from other agents with specialty insurance companies.
Management evaluates the agency segment's performance on the basis of
commission income generated and income before income taxes.
Chandler USA accounts for intercompany sales and transactions as if they
were to third parties and attempts to set fees consistent with those that
would apply in arm's length transactions with a nonaffiliate. There can be
no assurance the rates charged reflect those that would have been agreed upon
following an arm's length negotiation.
<PAGE>
PAGE F-23
The following table presents a summary of Chandler USA's operating
segments for the years ended December 31:
<TABLE>
<CAPTION>
PROPERTY
AND ALL INTERSEGMENT REPORTED
AGENCY CASUALTY OTHER ELIMINATIONS BALANCES
------------ ------------ ------------ ------------ ------------
(In thousands)
<S> <C> <C> <C> <C> <C>
1997
Revenues from external customers......................... $ 1,763 $ 81,284 $ - $ - $ 83,047
Intersegment revenues.................................... 7,277 201 - (7,478) -
Interest income, net..................................... 56 6,074 - - 6,130
Interest expense......................................... 1 441 - - 442
Segment profit (loss) before income taxes (1)............ 167 7,089 (1,970) - 5,286
Segment assets........................................... 6,177 203,125 - (6,515) 202,787
Depreciation and amortization............................ 121 936 1,047 - 2,104
1998
Revenues from external customers......................... $ 1,561 $ 52,607 $ - $ - $ 54,168
Intersegment revenues.................................... 7,088 197 - (7,285) -
Interest income, net..................................... 55 4,849 - - 4,904
Interest expense......................................... 2 885 - - 887
Segment profit (loss) before income taxes (1)............ 227 1,963 (1,404) - 786
Segment assets........................................... 5,323 222,620 - (4,592) 223,351
Depreciation and amortization............................ 107 1,179 1,048 - 2,334
1999
Revenues from external customers......................... $ 1,495 $ 97,084 $ - $ - $ 98,579
Intersegment revenues.................................... 8,171 178 - (8,349) -
Interest income, net..................................... 32 3,927 - - 3,959
Interest expense......................................... 1 1,495 - - 1,496
Segment profit (loss) before income taxes (1)............ 119 1,015 (856) - 278
Segment assets........................................... 4,604 261,364 - (9,132) 256,836
Depreciation and amortization............................ 83 1,494 648 - 2,225
- --------------------------------------------------
<FN>
(1) Includes net realized investment gains.
</TABLE>
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.
<PAGE>
PAGE F-24
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
INSURANCE PROGRAM 1997 1998 1999
- --------------------------------------------------------------------- -------------- -------------- --------------
(In thousands)
<S> <C> <C> <C>
NET PREMIUMS EARNED
Standard property and casualty....................................... $ 44,887 $ 29,234 $ 56,673
Political subdivisions............................................... 12,416 10,435 14,320
Surety bonds......................................................... 10,533 7,456 7,835
Group accident and health............................................ 2,303 4,610 8,195
Nonstandard private-passenger automobile............................. 8,841 482 4
Other................................................................ 1,722 207 71
-------------- -------------- --------------
$ 80,702 $ 52,424 $ 87,098
============== ============== ==============
LOSSES AND LOSS ADJUSTMENT EXPENSES
Standard property and casualty....................................... $ 30,709 $ 22,318 $ 46,099
Political subdivisions............................................... 7,218 8,403 14,734
Surety bonds......................................................... 828 1,335 310
Group accident and health............................................ 998 4,126 8,584
Nonstandard private-passenger automobile............................. 6,386 (182) (409)
Other................................................................ 2,374 50 (659)
-------------- -------------- --------------
$ 48,513 $ 36,050 $ 68,659
============== ============== ==============
</TABLE>
The following table shows the detail of intersegment eliminations for
segment assets shown in the previous table:
<TABLE>
<CAPTION>
1997 1998 1999
-------------- -------------- --------------
(In thousands)
<S> <C> <C> <C>
Segment asset eliminations
Investment in subsidiaries......................................... $ 365 $ 365 $ 5,565
Other consolidating adjustments.................................... 6,150 4,227 3,568
-------------- -------------- --------------
$ 6,515 $ 4,592 $ 9,133
============== ============== ==============
</TABLE>
* * * * * * *
<PAGE>
PAGE F-25
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, 1999 and 1998, 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, 1999.
Our audits also included the financial statement schedules listed in the
Index at Item 14. 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 generally accepted auditing
standards. 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, such consolidated financial statements present fairly, in all
material respects, the financial position of Chandler (U.S.A.), Inc. and
subsidiaries at December 31, 1999 and 1998, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 1999 in conformity with generally accepted accounting
principles. Also, in our opinion, such financial statement schedules, when
considered in relation to the basic consolidated financial statements taken
as a whole, present fairly, in all material respects, the information set
forth therein.
As discussed in Note 10 to the consolidated financial statements, Chandler
USA is involved in various legal proceedings, the outcome of which is uncertain.
/s/ Deloitte & Touche LLP
DELOITTE & TOUCHE LLP
Tulsa, Oklahoma
February 11, 2000
<PAGE>
PAGE F-26
SCHEDULE I
CHANDLER (U.S.A.), INC. AND SUBSIDIARIES
SUMMARY OF INVESTMENTS - OTHER
THAN INVESTMENTS IN RELATED PARTIES
AS OF DECEMBER 31, 1999
(In thousands)
<TABLE>
<CAPTION>
AMOUNT AT WHICH
SHOWN IN THE
TYPE OF INVESTMENT COST FAIR VALUE BALANCE SHEET
- ---------------------------------------------------------------------- ------------------ -------------- ---------------
<S> <C> <C> <C>
FIXED MATURITIES AVAILABLE FOR SALE:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies............................... $ 42,677 $ 41,490 $ 41,490
Debt securities issued by foreign governments......................... 1,503 1,498 1,498
Obligations of states and political subdivisions...................... 10,188 9,914 9,914
Corporate obligations................................................. 28,963 27,908 27,908
Public utilities...................................................... 6,194 5,792 5,792
Mortgage-backed securities............................................ 624 634 634
------------------ -------------- ---------------
90,149 87,236 87,236
FIXED MATURITIES HELD TO MATURITY:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies............................... 984 1,039 984
EQUITY SECURITIES AVAILABLE FOR SALE:
Corporate stock....................................................... - 306 306
------------------ -------------- ---------------
Total investments.................................................. $ 91,133 $ 88,581 $ 88,526
================== ============== ===============
</TABLE>
SEE INDEPENDENT AUDITORS' REPORT.
<PAGE>
PAGE F-27
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)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------
1998 1999
---------------- ----------------
<S> <C> <C>
ASSETS
Amounts due from subsidiaries........................................................ $ 2,693 $ 1,649
Property and equipment, net.......................................................... 2,494 2,367
Other assets......................................................................... 2,346 4,926
Excess of cost over net assets acquired, net......................................... 4,603 3,956
Investment in subsidiaries, net...................................................... 55,783 60,866
---------------- ----------------
Total assets......................................................................... $ 67,919 $ 73,764
================ ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Notes payable..................................................................... $ 9,410 $ -
Accrued taxes and other payables.................................................. 2,194 2,492
Amounts due to affiliate.......................................................... 7,054 533
Debentures........................................................................ - 24,000
---------------- ----------------
Total liabilities.................................................................... 18,658 27,025
---------------- ----------------
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............................................................... (12,040) (12,127)
Accumulated other comprehensive income (loss):
Unrealized gain (loss) on investments held by subsidiary and available
for sale, net of deferred income taxes...................................... 715 (1,720)
---------------- ----------------
Total shareholder's equity........................................................... 49,261 46,739
---------------- ----------------
Total liabilities and shareholder's equity........................................... $ 67,919 $ 73,764
================ ================
</TABLE>
SEE INDEPENDENT AUDITORS' REPORT.
<PAGE>
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)
STATEMENTS OF OPERATIONS
(In thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
1997 1998 1999
-------------- -------------- --------------
<S> <C> <C> <C>
Revenues
Interest income, net.............................................. $ 28 $ 20 $ 20
Commissions, fees and other income................................ 494 449 696
-------------- -------------- --------------
Total revenues................................................. 522 469 716
-------------- -------------- --------------
Operating costs and expenses
General and administrative expenses............................... 3,184 2,585 2,309
Interest expense.................................................. 407 809 1,439
Litigation expenses, net.......................................... 768 324 142
-------------- -------------- --------------
Total operating costs and expenses............................. 4,359 3,718 3,890
-------------- -------------- --------------
Loss before income tax benefit....................................... (3,837) (3,249) (3,174)
Federal income tax benefit........................................... 903 716 771
-------------- -------------- --------------
Net loss before equity in net income of subsidiaries................. (2,934) (2,533) (2,403)
Equity in net income of subsidiaries................................. 5,939 2,966 2,316
-------------- -------------- --------------
Net income (loss).................................................... $ 3,005 $ 433 $ (87)
============== ============== ==============
</TABLE>
SEE INDEPENDENT AUDITORS' REPORT.
<PAGE>
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 CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
1997 1998 1999
-------------- -------------- --------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss)................................................. $ 3,005 $ 433 $ (87)
Add (deduct):
Adjustments to reconcile net loss to cash provided by
(applied to) operating activities:
Net income of subsidiaries not distributed to parent........... (5,939) (2,966) (2,316)
Net (gains) losses on sale of property and equipment........... 1 - (16)
Amortization and depreciation expense.......................... 1,151 1,188 915
Net change in non-cash balances relating to
operating activities:
Premiums receivable......................................... 1,784 - -
Amounts due from subsidiaries............................... 1,846 (310) 1,044
Other assets................................................ (673) 147 (942)
Accrued taxes and other payables............................ 732 413 298
-------------- -------------- --------------
Cash provided by (applied to) operating activities............. 1,907 (1,095) (1,104)
-------------- -------------- --------------
INVESTING ACTIVITIES
Cost of property and equipment purchased.......................... (237) (2,453) (168)
Proceeds from sale of property and equipment...................... 20 133 92
-------------- -------------- --------------
Cash applied to investing activities........................... (217) (2,320) (76)
-------------- -------------- --------------
FINANCING ACTIVITIES
Shareholder dividend from subsidiary.............................. - 6,000 -
Proceeds from notes payable and debentures........................ - 8,548 24,000
Repayment of notes payable........................................ (1,595) (1,934) (9,410)
Debt issue costs.................................................. - - (1,689)
Proceeds from borrowing from affiliate............................ 6,707 6,043 3,805
Payments on borrowing from affiliate.............................. (6,802) (15,242) (15,526)
-------------- -------------- --------------
Cash provided by (applied to) financing activities............. (1,690) 3,415 1,180
-------------- -------------- --------------
Increase (decrease) in cash and cash equivalents..................... - - -
Cash and cash equivalents at beginning of year....................... - - -
-------------- -------------- --------------
Cash and cash equivalents at end of year............................. $ - $ - $ -
============== ============== ==============
</TABLE>
SEE INDEPENDENT AUDITORS' REPORT.
<PAGE>
PAGE F-30
SCHEDULE III
CHANDLER (U.S.A.), INC. AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
(In thousands)
<TABLE>
<CAPTION>
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
----------- -------- -------- ---------- --------- --------- ---------- ----------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
YEAR ENDED
DECEMBER 31, 1997
Property and casualty.. $ 3,475 $73,721 $42,389 $ 4,830 $ 80,702 $ 6,074 $ 48,513 $ 15,738 $ 9,482 $ 81,557
Agency................. - - - - - 56 - 7,081 1,896 -
Other.................. - - - - - - - - 1,971 -
----------- -------- -------- ---------- --------- --------- ---------- ----------- --------- ---------
Total.................. $ 3,475 $73,721 $42,389 $ 4,830 $ 80,702 $ 6,130 $ 48,513 $ 22,819 $ 13,349 $ 81,557
=========== ======== ======== ========== ========= ========= ========== =========== ========= =========
YEAR ENDED
DECEMBER 31, 1998
Property and casualty.. $ (80) $80,701 $50,647 $ 4,936 $ 52,424 $ 4,849 $ 36,050 $ 3,751 $ 9,643 $ 46,622
Agency................. - - - - - 55 - 6,934 1,540 -
Other.................. - - - - - - - - 1,404 -
----------- -------- -------- ---------- --------- --------- ---------- ----------- --------- ---------
Total.................. $ (80) $80,701 $50,647 $ 4,936 $ 52,424 $ 4,904 $ 36,050 $ 10,685 $ 12,587 $ 46,622
=========== ======== ======== ========== ========= ========= ========== =========== ========= =========
YEAR ENDED
DECEMBER 31, 1999
Property and casualty.. $ 3,134 $98,460 $67,769 $ 5,135 $ 87,098 $ 3,927 $ 68,659 $ 13,096 $ 10,129 $104,272
Agency................. - - - - - 32 - 8,064 1,514 -
Other.................. - - - - - - - - 855 -
----------- -------- -------- ---------- --------- --------- ---------- ----------- --------- ---------
Total.................. $ 3,134 $98,460 $67,769 $ 5,135 $ 87,098 $ 3,959 $ 68,659 $ 21,160 $ 12,498 $104,272
=========== ======== ======== ========== ========= ========= ========== =========== ========= =========
</TABLE>
SEE INDEPENDENT AUDITORS' REPORT.
<PAGE>
PAGE F-31
SCHEDULE IV
CHANDLER (U.S.A.), INC. AND SUBSIDIARIES
REINSURANCE
(Dollars in thousands)
<TABLE>
<CAPTION>
ASSUMED PERCENTAGE
CEDED TO FROM OF AMOUNT
GROSS OTHER OTHER NET ASSUMED
AMOUNT COMPANIES COMPANIES AMOUNT TO NET
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1997
Property and casualty.............. $ 123,014 $ (41,531) $ 74 $ 81,557 0.09 %
=========== ============ ============ ============ ===========
Year ended December 31, 1998
Property and casualty.............. $ 134,436 $ (87,671) $ (143) $ 46,622 (0.31)%
=========== ============ ============ ============ ===========
Year ended December 31, 1999
Property and casualty.............. $ 169,449 $ (65,297) $ 120 $ 104,272 0.12 %
=========== ============ ============ ============ ===========
</TABLE>
SEE INDEPENDENT AUDITORS' REPORT.
<PAGE>
PAGE F-32
SCHEDULE V
CHANDLER (U.S.A.), INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
<TABLE>
<CAPTION>
BALANCE AT PROVISION BALANCE
BEGINNING FOR AT END
OF PERIOD NON-COLLECTION WRITE-OFFS OF PERIOD
---------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Allowance for non-collection of
premiums receivable:
1997........................................... $ 177 $ 52 $ (114) $ 115
================ ================ ================ ================
1998........................................... $ 115 $ 152 $ (67) $ 200
================ ================ ================ ================
1999........................................... $ 200 $ 210 $ (147) $ 263
================ ================ ================ ================
Allowance for non-collection of reinsurance
recoverables on paid and unpaid losses:
1997........................................... $ 491 $ 527 $ (353) $ 665
================ ================ ================ ================
1998........................................... $ 665 $ 50 $ (110) $ 605
================ ================ ================ ================
1999........................................... $ 605 $ - $ (28) $ 577
================ ================ ================ ================
</TABLE>
SEE INDEPENDENT AUDITORS' REPORT.
<PAGE>
PAGE F-33
SCHEDULE VI
CHANDLER (U.S.A.), INC. AND SUBSIDIARIES
SUPPLEMENTAL INFORMATION
(FOR PROPERTY-CASUALTY INSURANCE UNDERWRITERS)
(In thousands)
<TABLE>
<CAPTION>
DISCOUNT PAID LOSSES AND
DEDUCTED LOSS ADJUSTMENT
FROM RESERVES EXPENSES
--------------- ---------------
<S> <C> <C>
Year ended December 31, 1997
Property-casualty........................................ $ - $ 48,481
=============== ===============
Year ended December 31, 1998
Property-casualty........................................ $ - $ 49,825
=============== ===============
Year ended December 31, 1999
Property-casualty........................................ $ - $ 57,106
=============== ===============
</TABLE>
SEE INDEPENDENT AUDITORS' REPORT.
<PAGE>
PAGE F-34
EXHIBIT 21.1
CHANDLER (U.S.A.), INC. AND SUBSIDIARIES
SUBSIDIARIES OF THE REGISTRANT
1. National American Insurance Company, a Nebraska corporation ("NAICO") that
is a wholly owned subsidiary of Chandler USA.
2. LaGere & Walkingstick Insurance Agency, Inc., an Oklahoma corporation
("L&W") that is a wholly owned subsidiary of Chandler USA.
3. Network Administrators, Inc., a Texas corporation ("Network") that is a
wholly owned subsidiary of Chandler USA.
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
This schedule contains summary financial information extracted from
Chandler (U.S.A.), Inc.'s December 31, 1999 Form 10-K and is qualified
entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> DEC-31-1999
<DEBT-HELD-FOR-SALE> 87,236
<DEBT-CARRYING-VALUE> 984
<DEBT-MARKET-VALUE> 1,039
<EQUITIES> 306
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 88,526
<CASH> 5,140
<RECOVER-REINSURE> 3,281
<DEFERRED-ACQUISITION> 3,134
<TOTAL-ASSETS> 256,836
<POLICY-LOSSES> 98,460
<UNEARNED-PREMIUMS> 67,769
<POLICY-OTHER> 5,135
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
0
0
<COMMON> 2
<OTHER-SE> 46,737
<TOTAL-LIABILITY-AND-EQUITY> 256,836
87,098
<INVESTMENT-INCOME> 3,959
<INVESTMENT-GAINS> 57
<OTHER-INCOME> 11,481
<BENEFITS> 68,659
<UNDERWRITING-AMORTIZATION> 21,160
<UNDERWRITING-OTHER> 12,498
<INCOME-PRETAX> 278
<INCOME-TAX> 365
<INCOME-CONTINUING> (87)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (87)
<EPS-BASIC> (34.66)
<EPS-DILUTED> (34.66)
<RESERVE-OPEN> 39,921
<PROVISION-CURRENT> 65,139
<PROVISION-PRIOR> 3,520
<PAYMENTS-CURRENT> 33,210
<PAYMENTS-PRIOR> 23,896
<RESERVE-CLOSE> 51,378
<CUMULATIVE-DEFICIENCY> 3,520
</TABLE>
