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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------------
FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
--- SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1997
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
--- SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from ________ to ________
Commission File Number: 0-15286
CHANDLER INSURANCE COMPANY, LTD.
(Exact name of registrant as specified in its charter)
CAYMAN ISLANDS NONE
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5TH FLOOR ANDERSON SQUARE N/A
P.O. BOX 1854 (Zip Code)
GRAND CAYMAN, CAYMAN ISLANDS B.W.I.
(Address of principal executive offices)
Registrant's telephone number, including area code: 345-949-8177
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON SHARES, $1.67 PAR VALUE
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
---
The aggregate market value of the voting stock held by non-affiliates of
the registrant on February 28, 1998 was $15,829,488 (all currency is expressed
in U.S. dollars). See "ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT" regarding registrant's assumptions about affiliates and
possible changes in control.
The number of common shares, $1.67 par value, of the registrant
outstanding on February 28, 1998 was 6,941,708, which includes 494,617 common
shares owned by a subsidiary of the registrant which are eligible to vote, and
1,660,125 common shares which were rescinded through litigation and are held
by
a court. See "ITEM 3. LEGAL PROCEEDINGS".
DOCUMENTS INCORPORATED BY REFERENCE
Registrant does not incorporate by reference in this report any annual
report, proxy statement, or Rule 424 prospectus.
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<PAGE>
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 Insurance Company, Ltd. (the "Company") in
periodic
press releases, oral statements made by the Company's officials to analysts
and
shareholders in the course of presentations about the Company 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 the Company 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 the Company operates; (iv) claims frequency;
(v) claims severity; (vi) the number of new and renewal policy applications
submitted by the Company's agents; and (vii) other factors such as the ongoing
litigation matters involving a significant concentration of ownership of
common
stock.
ITEM 1. BUSINESS
GENERAL
The Company is a holding company organized and domiciled in the Cayman
Islands whose wholly owned subsidiaries are engaged in various property and
casualty insurance and reinsurance operations. The insurance products are
underwritten by National American Insurance Company ("NAICO"), a Nebraska
insurance company that is a wholly owned subsidiary of the Company. NAICO
primarily provides property and casualty coverage for businesses in various
industries, political subdivisions, nonstandard private-passenger automobiles
and surety bonds for small contractors. NAICO is licensed in 44 of the United
States and the District of Columbia and is authorized by the United States
Department of the Treasury to write surety bonds for contractors on federal
projects.
NAICO is rated "A- (Excellent)" by A.M. Best Company. A.M. Best
Company's
ratings range from the highest rating of "A++ (Superior)" to the lowest rating
of "F (in Liquidation)". These ratings are an independent opinion of a
company's financial strength, operating performance and ability to meet its
obligations to policyholders.
Chandler Insurance (Barbados), Ltd. ("Chandler Barbados"), a Barbados
company and a wholly owned subsidiary of the Company, principally reinsures
risks underwritten by NAICO. NAICO retains a portion of each risk, then
transfers the balance to other reinsurance companies including Chandler
Barbados. Such reinsurance arrangements are governed by reinsurance contracts
between NAICO and each of its reinsurers and Chandler Barbados and each of its
reinsureds.
One of the Company's wholly owned subsidiaries, LaGere & Walkingstick
Insurance Agency, Inc. ("L&W"), an independent insurance agency based in
Chandler, Oklahoma, represents various insurance companies, including NAICO,
that provide a variety of property-casualty, life and accident and health
coverages. L&W also acts as a surplus lines broker specializing in risk
management and brokering insurance for high risk ventures.
The Company conducts its business from the Cayman Islands in the British
West Indies and is not subject to regulation as an insurance company in any
jurisdiction within the United States of America. The Company is, however,
subject to certain regulations of The Monetary Authority in the Cayman
Islands.
Chandler Barbados is subject to similar Barbados regulations. See
"Regulation". 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 by
the United States companies it reinsures to secure its reinsurance obligations
by depositing acceptable securities in a trust for the benefit of the company
ceding such obligations or by letters of credit in favor of the ceding
company.
See "Trust Arrangements and Special Deposits". NAICO is subject to minimum
capital, audit, reporting, dividend and other requirements imposed by
regulation upon United States insurance companies. See "Regulation".
STANDARD PROPERTY-CASUALTY PROGRAM
Insurance products offered in NAICO's standard property-casualty program
include workers compensation, automobile liability and physical damage,
general
and umbrella liability and property coverages. Target industries or classes
of
business include nursing homes, home healthcare, construction, retail,
manufacturers, wholesalers and service and retail companies. This business is
principally written in the states of Oklahoma, Texas, Illinois and Georgia.
POLITICAL SUBDIVISIONS PROGRAM
In 1990, NAICO began writing property-casualty coverage for school
districts in Oklahoma. L&W had produced this business since 1983 for
unrelated
insurers. The coverages offered include workers compensation, automobile
liability, general liability, property and school board legal liability.
<PAGE>
PAGE
2
In 1991, NAICO began writing property-casualty insurance for
municipalities. The coverages include automobile and general liability,
property and public officials liability insurance. Since 1991, NAICO has
restricted its underwriting to Oklahoma municipalities. In 1995, NAICO began
offering workers compensation in addition to the other coverages. In
mid-1995,
NAICO began insuring counties in Oklahoma for automobile and general
liability,
property and public officials liability.
SURETY BOND PROGRAM
NAICO writes surety bonds, commonly called performance bonds, to secure
the performance of contractors and suppliers on construction projects.
Individual bonds generally do not exceed $4.0 million and work in progress for
an individual contractor generally does not exceed $7.0 million. A
substantial
portion of this business is written in Oklahoma, Texas, New Mexico and
California. NAICO also writes court bonds which guarantee that the principal
will discharge obligations set by the court, as well as various types of
miscellaneous bonds.
NONSTANDARD PRIVATE-PASSENGER AUTOMOBILE PROGRAM
In late 1993, NAICO began writing nonstandard private-passenger
automobile
liability and automobile physical damage in Oklahoma. Policy limits for
automobile liability are $10,000 each person and $20,000 each loss occurrence
for bodily injury and $10,000 for property damage. During mid-1994, NAICO
began writing a similar program in California and Arizona. California and
Arizona policy limits are $15,000 each person and $30,000 each loss occurrence
for bodily injury and $10,000 for property damage. The Arizona and California
portions of the program are produced by an underwriting manager headquartered
in California.
During the second quarter of 1997, management reviewed the underwriting
performance of the California portion of the program and concluded that it
would be in the Company's best interest to substantially reduce its
underwriting risk. Effective July 1, 1997, NAICO entered into a 100% quota
share reinsurance agreement with Underwriters Reinsurance Company to fully
reinsure the risk. In December 1997, the reinsurance contract was amended and
Jefferson Insurance Company of New York replaced Underwriters Reinsurance
Company.
The Oklahoma and Arizona portions of the program were discontinued in
1997.
GROUP ACCIDENT AND HEALTH PROGRAM
Effective January 1, 1996, NAICO began offering excess accident and
health
coverage for small to medium-sized employers that self-insure a portion of
their company medical plans. This business is generally written in Oklahoma
and Texas.
VOLUNTARY AND INVOLUNTARY POOLS, ASSOCIATIONS AND ASSIGNED RISKS
NAICO participates in various voluntary and involuntary insurance pools
and associations ("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.
AGENCY AND BROKERAGE
L&W is appointed by insurers to solicit applications for policies of
insurance primarily in Oklahoma. L&W represents diverse personal and
commercial lines insurance companies regarding property-casualty insurance.
L&W also markets individual and group life, medical and disability income
coverage. Major target classes of business are political subdivisions,
healthcare facilities, transportation companies, manufacturers, contractors,
oil & gas business, 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 high risk ventures. L&W places direct agency
business as well as business from other agents with specialty insurance
companies.
RISK MANAGEMENT SERVICES
In October 1995, the Company purchased all of the capital stock of
Network
Administrators, Inc. ("Network"). Network is a Texas corporation based in
Dallas, Texas and is a third-party administrator involved in structuring and
administering partially self-insured group accident and health plans for
employers. Network's operations were consolidated into a joint venture in the
third quarter of 1997. Effective December 31, 1997, Network's participation
in
the joint venture was terminated. Network no longer functions as a
third-party
administrator.
Since 1987, NAICO has offered risk management services on an unbundled
basis to certain insurance customers. In 1995, NAICO and L&W began to offer
unbundled risk management services and flexible risk transfer products using
the trade name "Chandler Risk Services". Such products and services are
offered by NAICO, L&W or other subsidiaries of the Company and include claim
management, loss control, reinsurance, policy issuance and other risk
management services.
<PAGE>
PAGE
3
UNDERWRITING AND CLAIMS
Independent insurance agents submit applications for insurance coverage
for prospective customers to NAICO and, for certain insurance programs, to
underwriting managers. NAICO personnel and/or the underwriting managers
review
a prospective risk in accordance with specific underwriting guidelines set by
NAICO. If the risk is approved and coverage is accepted by the insured, a
NAICO insurance policy is issued.
NAICO's largest unaffiliated independent insurance agent during 1995 was
responsible for producing $11.0 million of NAICO's direct written and assumed
premiums. There were no unaffiliated independent insurance agents that
produced 10% or more of NAICO's direct written and assumed premiums during
1996
or 1997.
The underwriting managers are independent contractors to NAICO and are
compensated on a commission basis for their underwriting services. Each
underwriting manager is responsible for all commissions payable to any
independent insurance agent who produces the insurance business. In addition,
the underwriting managers pay all salaries and expenses of personnel who
perform and support the underwriting activities as well as other incidental
expenses.
NAICO's largest underwriting manager was responsible for underwriting
$11.5 million, $11.9 million and $12.3 million of NAICO's direct written and
assumed premiums for the California and Arizona portions of the nonstandard
private-passenger automobile program in 1995, 1996 and 1997, respectively.
Premiums receivable and currently due from this underwriting manager were
$596,000 and $612,000 at December 31, 1996 and 1997, respectively.
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 the class of
business. NAICO's claim department is responsible for reviewing each claim,
obtaining necessary documentation and establishing loss and loss adjustment
expense reserves. All claims are monitored by the in-house claims staff which
handle or supervise the claims, coordinate with outside legal counsel and
independent claims adjusters if necessary, and process the claims to
conclusion.
REINSURANCE
In the ordinary course of business, NAICO cedes insurance risks and a
portion of the insurance premiums to its reinsurers under various reinsurance
contracts that cover individual risks (facultative reinsurance) or entire
classes of business (treaty reinsurance). Reinsurance provides greater
diversification of insurance risk associated with business written and also
reduces NAICO's exposure from high policy limits or from catastrophic events
and hazards of an unusual nature. Amounts recoverable from reinsurers are
estimated in a manner consistent with the claim liability associated with the
reinsured policy.
NAICO has structured separate reinsurance programs for 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 surety bonds, workers
compensation and casualty reinsurance programs.
Under the 1997 workers compensation reinsurance program, the combined net
retention for NAICO and Chandler Barbados was $1,000,000 of loss per
occurrence. Effective February 1, 1998, the combined net retention was
reduced
to $500,000 of loss per occurrence. The combined net retention under the 1997
casualty reinsurance program was $500,000 of loss per occurrence. Effective
February 1, 1998, the combined net retention was reduced to $250,000 of loss
per occurrence. The combined net retention under the surety bond reinsurance
program is $500,000 per bond or per principal (e.g. contractor). NAICO
retains
30% of the first $500,000 of risk for each loss per location under its
property
reinsurance program. 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.
In addition, NAICO purchases catastrophe protection to limit its
retention
for single loss occurrences involving multiple policies and/or policyholders,
resulting from perils 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 and July 1 of each
year. NAICO renewed all January 1 reinsurance programs. At the present time,
NAICO expects to renew the reinsurance programs on April 1 and July 1.
<PAGE>
PAGE
4
In formulating its reinsurance programs, NAICO considers numerous
factors,
including the financial stability of the reinsurer, its ability to provide
sufficient collateral if required, coverage offered and price.
The following table sets forth certain information related to NAICO and
NAICO Indemnity (Cayman), Ltd.'s ("NAICO Indemnity") five largest reinsurers
(excluding Chandler Barbados) by net reinsurance recoverables as of December
31, 1997. NAICO Indemnity is a Cayman Islands company and is a wholly owned
subsidiary of the Company which is in a run-off position.
<TABLE>
<CAPTION>
NET CEDED A.M.
REINSURANCE REINSURANCE BEST
CO.
NAME OF REINSURER RECOVERABLE (1) PREMIUMS
RATING
- --------------------------------- --------------- ---------------
- --------
(Dollars in thousands)
<S> <C> <C> <C>
Jefferson Insurance
Company of New York.......... $ 4,523 $ 7,473 A
National Union Fire Insurance
Company of Pittsburgh (2).... 3,930 - A++
SCOR Reinsurance Company......... 3,831 4,756 A+
National American Insurance
Company of California........ 1,123 - B++
Transamerica Occidental
Life Insurance Company....... 1,122 11 A+
--------------- ---------------
Top five reinsurers.......... $ 14,529 $ 12,240
=============== ===============
All reinsurers............... $ 23,607 $ 26,222
=============== ===============
Percentage of total represented
by top five reinsurers....... 61.5% 46.7%
- ---------------------------------
<FN>
(1) Includes losses and loss adjustment expenses paid and outstanding, unpaid
losses and loss adjustment expenses and unearned premium reserves
recoverable from reinsurers as of December 31, 1997.
(2) National Union Fire Insurance Company of Pittsburgh, Pennsylvania assumed
the reinsurance obligations of DuraRock Underwriters, Ltd. effective
March
31, 1993. See Notes to Consolidated Financial Statements.
</TABLE>
Reinsurance contracts do not relieve an insurer from its obligation to
policyholders. Failure of reinsurers to honor their obligations could result
in losses to the Company; consequently, allowances are established for amounts
deemed uncollectible. During 1995, 1996 and 1997, NAICO charged to policy
acquisition costs $440,000, $2.1 million and $527,000, respectively, in
uncollectible reinsurance recoverables from unaffiliated reinsurers. See
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS".
LINES OF INSURANCE UNDERWRITTEN
The following table shows the percentage of net premiums earned by line
of
insurance underwritten by the Company during the period indicated. The term
"net premiums earned" means net premiums written less the increases or plus
the
decreases in the unearned premium reserve for the unexpired portion of the
policy term beyond the current accounting period. See "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS".
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- ------------------------------------------
1993 1994 1995 1996
1997
------ ------ ------ ------
- ------
<S> <C> <C> <C> <C> <C>
Workers compensation.................. 42% 48% 46% 48%
47%
Automobile liability.................. 16 17 19 20
16
Other liability....................... 4 6 8 10
13
Surety and fidelity................... 36 24 18 11
12
Automobile physical damage............ 1 3 7 8
6
Accident and health................... - 1 - -
3
Property.............................. 1 1 2 2
2
Inland marine......................... - - - 1
1
------ ------ ------ ------
- ------
Total.............................. 100% 100% 100% 100%
100%
====== ====== ====== ======
======
</TABLE>
LOSS AND UNDERWRITING EXPENSE RATIOS
The combined loss and underwriting expense ratio is the traditional
measure of underwriting experience for property-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
5
The following table shows the underwriting experience of the Company 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 have been defined to 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,
------------------------------------------------
1993 1994 1995 1996 1997
-------- -------- -------- --------
- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Workers compensation:
Net premiums earned.........$32,675 $39,183 $37,066 $42,813
$44,954
Loss ratio.................. 74% 65% 62% 53%
66%
Automobile liability:
Net premiums earned.........$12,727 $13,551 $15,498 $17,581
$15,593
Loss ratio.................. 104% 108% 74% 98%
89%
Other liability:
Net premiums earned.........$ 3,380 $ 4,759 $ 6,579 $ 8,656
$12,209
Loss ratio.................. 84% 63% 43% 60%
49%
Surety and fidelity:
Net premiums earned.........$28,862 $19,950 $14,237 $10,123
$11,256
Loss ratio.................. 39% 51% 56% (1)%
9%
Automobile physical damage:
Net premiums earned.........$ 732 $ 2,342 $ 5,881 $ 6,788 $
5,726
Loss ratio.................. 50% 64% 68% 74%
60%
Accident and health:
Net premiums earned.........$ 384 $ 754 $ 230 $ 564 $
2,529
Loss ratio.................. 83% 70% (49)% 56%
43%
Property:
Net premiums earned.........$ 530 $ 982 $ 1,369 $ 1,467 $
1,912
Loss ratio.................. 58% 80% 73% 114%
74%
Inland marine:
Net premiums earned.........$ 10 $ 76 $ 227 $ 1,294 $
500
Loss ratio.................. (945)% (154)% 84% 115%
195%
Total:
Net premiums earned.........$79,300 $81,597 $81,087 $89,286
$94,679
Loss ratio.................. 66% 69% 62% 60%
61%
Underwriting expense
ratio (1)............... 41% 34% 39% 46%
39%
-------- -------- -------- --------
- --------
Combined loss and
underwriting expense
ratio (1)............... 107% 103% 101% 106%
100%
======== ======== ======== ========
========
- --------------------------------
<FN>
(1) Litigation costs are not considered underwriting expenses; therefore,
such
costs have been excluded from this ratio. The 1996 underwriting expense
ratio was increased by 4 percentage points by a reinsurance arbitration
adjustment and the termination of relations with the Company's former
surety bond underwriting manager. See "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS".
</TABLE>
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 unreported 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 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 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, 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. See
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS".
<PAGE>
PAGE 6
NAICO periodically reviews the reserve estimates relating to insurance
business written or assumed by NAICO and Chandler Barbados 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 the Company's net
liability for losses and loss adjustment expenses were approximately $3.6
million and $3.8 million at December 31, 1996 and 1997, respectively. See
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS" and Notes to Consolidated Financial Statements.
Chandler Barbados reports its reserves on the basis of United States
generally accepted accounting principles ("U.S. GAAP"), which does not differ
from the manner in which they are reported to The Monetary Authority of the
Cayman Islands and the Supervisor of Insurance of Barbados. NAICO's
statutory-
based reserves do not differ from its U.S. GAAP reserves. Neither NAICO nor
Chandler Barbados discounts its reserves for unpaid losses and 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 residual market direct assignments.
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 described by state law and are
estimated
based on the same factors generally discussed above, with actuarial input,
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.
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,
- --------------------------------------------------------------
1993
1994 1995 1996 1997
----------
- ---------- ---------- ---------- ----------
(Dollars in thousands)
<S> <C>
<C> <C> <C> <C>
Net balance before provision for uncollectible
reinsurance and reclassification of Pool
liabilities at beginning of year (1)................ $ 119,963 $
98,871 $ 86,512 $ 70,006 $ 53,048
----------
- ---------- ---------- ---------- ----------
Net losses and loss adjustment expenses
incurred related to:
Current year..................................... 47,265
54,753 50,975 53,314 53,704
Prior years...................................... 5,239
1,119 (432) 77 3,808
----------
- ---------- ---------- ---------- ----------
Total......................................... 52,504
55,872 50,543 53,391 57,512
----------
- ---------- ---------- ---------- ----------
Net paid losses and loss adjustment
expenses related to:
Current year..................................... (12,179)
(18,433) (21,106) (23,836) (22,214)
Prior year....................................... (61,417)
(49,798) (45,943) (46,513) (36,838)
----------
- ---------- ---------- ---------- ----------
Total......................................... (73,596)
(68,231) (67,049) (70,349) (59,052)
----------
- ---------- ---------- ---------- ----------
Net balance before provision for uncollectible
reinsurance and reclassification of Pool
liabilities at end of year (1)...................... 98,871
86,512 70,006 53,048 51,508
Reclassification of Pool liabilities (1)............... 15,694
11,382 11,382 11,382 11,382
Adjustments to reinsurance recoverables on unpaid
losses for uncollectible reinsurance................ 814
698 629 777 1,163
----------
- ---------- ---------- ---------- ----------
Net balance at end of year............................. $ 115,379 $
98,592 $ 82,017 $ 65,207 $ 64,053
- ------------------------------------------------------- ==========
========== ========== ========== ==========
<FN>
(1) The reclassification of Pool liabilities represents the Company's
proportionate share of unpaid losses resulting from NAICO's participation
in various Pools. Subsequent to December 31, 1994, changes in the
estimate for and payments of Pool liabilities are included with changes
in
the estimate for and payments of all other claim liabilities. See
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS" and Notes to Consolidated Financial Statements.
</TABLE>
<PAGE>
PAGE
7
The following table represents the development of net balance sheet
reserves for 1988 through 1997. 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 changes as more information becomes known about the frequency and
severity of claims for individual years. The next portion of the table shows
the re-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 six years presented.
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 1991 for
claims
that occurred in 1988 will be included in the cumulative deficiency amount for
years 1988, 1989, 1990 and 1991. 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,
- --------------------------------------------------------------------------------
- -----------------------------
1988 1989 1990 1991 1992
1993 1994 1995 1996 1997
---------- ---------- ---------- ---------- ----------
- ---------- ---------- ---------- ---------- ----------
(Dollars in
thousands)
<S> <C> <C> <C> <C> <C>
<C> <C> <C> <C> <C>
Net reserve for
unpaid losses and
loss adjustment
expenses (1).......$ 30,274 $ 62,738 $ 125,348 $ 144,430 $ 119,963 $
99,685 $ 98,592 $ 82,017 $ 65,207 $ 64,053
Net paid (cumulative)
as of
One year later..... 15,070 35,715 67,898 78,323 61,417
49,798 45,943 46,513 36,837
Two years later.... 29,561 71,176 114,793 120,319 94,047
73,225 72,718 65,754
Three years later.. 44,893 89,987 136,134 144,900 109,885
90,909 85,006
Four years later... 51,564 98,556 150,709 155,816 122,757
98,193
Five years later... 53,771 104,545 155,589 165,357 127,725
Six years later.... 55,295 106,418 159,396 168,509
Seven years later.. 55,897 108,216 160,358
Eight years later.. 56,267 108,542
Nine years later... 56,622
Net liability
re-estimated
as of (1)
One year later..... 33,432 84,534 144,798 160,938 125,202
100,804 98,160 82,094 69,015
Two years later.... 41,558 100,219 156,986 163,100 127,557
101,467 96,279 84,023
Three years later.. 51,887 106,624 157,264 166,807 129,449
101,539 98,549
Four years later... 54,935 107,097 160,961 167,935 129,958
102,626
Five years later... 55,298 109,262 160,481 169,143 131,109
Six years later.... 55,914 108,652 160,736 170,077
Seven years later.. 56,084 108,635 161,117
Eight years later.. 56,278 108,645
Nine years later... 56,562
Net cumulative
(deficiency)
redundancy.........$ (26,288) $ (45,907) $ (35,769) $ (25,647) $ (11,146) $
(2,941) $ 43 $ (2,006) $ (3,808) $ -
Supplemental Gross Data:
Gross liability after reclassification of
Pools - end of year..........................................$ 225,610 $
179,815 $ 156,060 $ 128,794 $ 79,639 $ 74,929
Reclassification of Pool liabilities (1)....................... (18,875)
(15,694) - - - -
Gross liability before reclassification of
Pools - end of year (1)......................................$ 206,735 $
164,121 $ 156,060 $ 128,794 $ 79,639 $ 74,929
Reinsurance recoverable........................................ 86,772
64,436 57,468 46,777 14,432 10,876
Net liability - end of year (1)................................$ 119,963 $
99,685 $ 98,592 $ 82,017 $ 65,207 $ 64,053
Gross re-estimated liability - latest (1)......................$ 209,652 $
161,657 $ 154,404 $ 130,527 $ 86,292
Re-estimated recoverable - latest.............................. 78,543
59,031 55,855 46,504 17,277
Net re-estimated liability - latest (1)........................$ 131,109 $
102,626 $ 98,549 $ 84,023 $ 69,015
Gross cumulative (deficiency) redundancy.......................$ (2,917)
$ 2,464 $ 1,656 $ (1,733) $ (6,653)
- -----------------------------------------------------------------
<FN>
(1) The December 31, 1993 and prior amounts do not include the
reclassification of Pool liabilities. See "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS".
</TABLE>
<PAGE>
PAGE
8
TRUST ARRANGEMENTS AND SPECIAL DEPOSITS
Under the reinsurance arrangements with NAICO, Chandler Barbados has
entered into a trust arrangement and established a trust account in favor of
NAICO into which investments are deposited. The amount required in the trust
account is adjusted periodically to secure reserves for unpaid claims,
unearned
premiums, reserves for unpaid allocated loss adjustment expenses and reserves
for incurred but not reported claims after giving effect for any reinsurance
premiums receivable from NAICO. NAICO requires substantially the same trust
arrangements or irrevocable letters of credit from all of its non-admitted
reinsurers. This not only provides security to NAICO concerning such
reinsurance obligations but also enables NAICO to take credit on its statutory
financial statements for such reinsurance pursuant to state laws and
regulations.
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. NAICO has also deposited funds pursuant to a trust arrangement
securing reinsurance obligations it has assumed from an unrelated primary
carrier. For additional information see Notes to Consolidated Financial
Statements.
INVESTMENTS
Funds available for investment include the Company's present capital as
well as premiums received and retained under insurance policies and
reinsurance
agreements issued by its subsidiaries. Until these funds are required to be
used for the settlement of claims and the payment of operating expenses of the
Company's subsidiaries, they are invested with the objective of generating
income, preserving principal and maintaining liquidity.
Fixed-maturity investments are purchased to support the investment
strategies of the Company 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 the Company 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.
The
Company 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 tax as a separate component of shareholders'
equity until realized.
Realized gains and losses on sales of securities are based on the
specific
certificate identification method and included in net investment income in the
accompanying consolidated statements of operations.
As of December 31, 1997 all of the investments of Chandler Barbados and
of
NAICO were in fixed-maturity investments (rated Aa3 or AA- or better by
Moody's
Investors Service, Inc. or Standard & Poor's, respectively), certificates of
deposit (insured by the Federal Deposit Insurance Corporation), interest-
bearing money market accounts, a collateralized repurchase agreement and
common
stock received in connection with an unaffiliated entity's conversion to a
for-
profit corporation. Madison Scottsdale, L.C. is responsible for managing
$15.9
million of Chandler Barbados' portfolio at December 31, 1997. The remainder
is
managed by the Investment Committee of the Company's Board of Directors.
Approximately $85.0 million of NAICO's investment portfolio at December 31,
1997 is managed by Madison Scottsdale, L.C. The remainder is managed by the
Investment Committee of its Board of Directors. For additional information,
see "Trust Arrangements and Special Deposits" and Notes to Consolidated
Financial Statements.
During 1997, NAICO received 19,371 shares of class B common stock of the
Insurance Services Office, Inc. ("ISO") in connection with ISO's conversion to
a for-profit corporation. ISO has placed certain limitations on the transfer
or sale of the class B common stock one of which restricts ownership of the
shares to insurance companies whose primary activity is the writing of
insurance or the reinsuring of risk underwritten by insurance companies.
EMPLOYEES AND ADMINISTRATION
The Company and Chandler Barbados have no employees. Day-to-day
management of the Company's operations and administrative affairs is performed
in the Cayman Islands by Chandler Insurance Management, Ltd. ("CIM"), a wholly
owned subsidiary of the Company. Day-to-day management of Chandler Barbados'
operations and administrative affairs is performed in Barbados by Chandler
Insurance Management (Barbados), Ltd. ("CIM Barbados"), a wholly owned
subsidiary of the Company. Steven R. Butler, the Vice
President-Administration
of the Company and the President of Chandler Barbados, is the Financial
Director of CIM and the Treasurer and a director of CIM Barbados.
At December 31, 1997, the subsidiaries of the Company organized under the
laws of the United States had approximately 332 full-time employees. The
subsidiaries have generally enjoyed good relations with their employees.
<PAGE>
PAGE
9
REGULATION
REGULATION IN GENERAL
The Company's insurance subsidiaries are subject to regulation by
government agencies in the jurisdictions in which they do 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, 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 security holders.
In addition to the regulatory oversight of the Company's insurance
subsidiaries, the Company is also subject to regulation under the laws of the
Cayman Islands and the Nebraska Insurance Holding Company System Act (the
"Holding Company Act"). The Holding Company Act contains certain reporting
requirements including those requiring the Company, 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.
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 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 Company and NAICO Indemnity hold Unrestricted Class "B" Insurer's
Licenses under provisions of the Insurance Law (1995 Revision) as amended of
the Cayman Islands (the "Cayman Insurance Law"). An insurance company that is
issued a Class "B" Insurer's License in the Cayman Islands is limited to
writing insurance risks in jurisdictions other than the Cayman Islands.
The Company, NAICO Indemnity and CIM are regulated by The Monetary
Authority in the Cayman Islands and must comply with the Cayman Insurance Law.
The Monetary Authority has broad discretionary powers to regulate the
operations of insurance companies in the Cayman Islands, including among other
things the approval of shareholders that may own shares in such companies and
the establishment of insurance ratio guidelines such as the ratio of net
premium income to shareholders' equity. Such regulation is generally less
restrictive than that of state insurance regulatory agencies in the United
States.
The Cayman Insurance Law requires a licensed insurer to provide annual
audited financial statements. The Company, NAICO Indemnity and CIM prepare
their financial statements in accordance with U.S. GAAP. The Monetary
Authority is charged with the responsibility of ensuring that licensed
insurers
comply with the provisions of the law, are in a sound financial position and
are carrying on business in a satisfactory manner.
The Cayman Islands currently does not have restrictions or exchange
controls applicable to the Company or NAICO Indemnity concerning the transfer
of any funds into or out of the Cayman Islands.
Under the Cayman Insurance Law, any change in the information supplied on
the application for the license must receive the prior approval of The
Monetary
Authority. Therefore, licensed insurers must generally obtain prior approval
of The Monetary Authority of changes in their shareholders or their
shareholdings. The Company has, however, obtained an exemption from such
approval for shareholders owning 5% or less of the issued common shares of the
Company. CIM obtained prior approval from The Monetary Authority before
acquiring common shares of the Company.
Chandler Barbados is licensed as an "exempt insurance company" by the
Barbados Minister of Finance pursuant to the Barbados Exempt Insurance Act,
Chapter 308A. That statute requires the maintenance of a minimum level of
capital, payment of applicable license fees, annual preparation and filing of
audited financial statements, and establishes standards of solvency that must
be maintained. Exempt insurance companies are exempted from the provisions of
the Barbados Exchange Control Act. Chandler Barbados and CIM Barbados are
subject to regulation by the Supervisor of Insurance in Barbados.
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.
<PAGE>
PAGE
10
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 relevant insurance regulatory authority. 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 admitted insurance company 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 admitted insurer if certain conditions exist such as undue
market concentration.
Any future transactions that would constitute a change in control of the
Company would also generally require prior approval by the Insurance
Department
of Nebraska and would require pre-acquisition notification in those states
which have adopted pre-acquisition notification provisions and in which the
insurers are admitted. Since such requirements are primarily for the benefit
of
policyholders, they may deter, delay or prevent certain transactions that
could
be advantageous to the stockholders of the Company.
RESTRICTIONS ON DIVIDENDS
A significant portion of the Company's consolidated assets represents
assets of the Company's insurance subsidiaries that may not be transferable to
the holding company in the form of dividends, loans or advances. The Company's
insurance subsidiaries are subject to various state statutory and regulatory
restrictions, generally applicable to each insurance company in its state of
incorporation, which limit the amount of dividends or distributions by an
insurance company to its stockholders. The restrictions are generally based on
certain levels of surplus, operating income and investment income, as
determined under statutory accounting practices.
The Holding Company Act regulates the distribution of dividends and other
payments to the Company by its subsidiaries. Under the applicable Nebraska
statute, the maximum discretionary dividend that may be declared (or
cash/property distribution that may be made) by NAICO is the greater of (i)
the
insurance company's net income (excluding realized capital gains) for the
preceding calendar year plus 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) ten percent of the insurance company's
policyholders' surplus for the preceding calendar year, excluding unrealized
gains. These dividends are further limited by a clause in the Nebraska law
which prohibits an insurer from declaring dividends except out of earned
surplus of the company, as allowed under the Insurance Code.
The payment of cash dividends by Chandler Barbados is limited to its
realized earned surplus and margin of solvency requirements.
Chandler Barbados and NAICO (during ownership by the Company) have not
paid any cash shareholder dividends. See Notes to Consolidated Financial
Statements.
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 which 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 a 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, a company
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 risk-based capital rules provide for different levels
of regulatory attention depending on the ratio of a company's total adjusted
capital to its "authorized control level" ("ACL") of RBC. At December 31,
1997, NAICO's statutory surplus was $45.3 million; the threshold requiring
regulatory involvement was $7.7 million. Therefore, NAICO's capital exceeds
the level that would trigger regulatory attention pursuant to the Risk-Based
Capital Model Act.
<PAGE>
PAGE
11
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 on four or more ratios generally leads to inquiries from
individual state insurance commissioners. In 1997, NAICO had no ratios which
varied from the "usual value" ranges.
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.
TAXATION
The following summary of certain United States and foreign taxes is based
upon the Company's understanding of applicable tax law. The tax treatment of
an investment in the Company's common shares may vary depending upon a
shareholder's individual circumstances. Certain shareholders, such as foreign
corporations, may be subject to special rules not discussed below.
FOREIGN TAXES. The Company, Chandler Barbados and NAICO Indemnity are
not
obligated to pay any income or capital gains taxes in the Cayman Islands or
Barbados. The Company is required to pay an annual fee based on its
authorized
capital, plus an annual license fee. Chandler Barbados is required to pay an
annual license fee. The Company, NAICO Indemnity and Chandler Barbados have
received tax concession guarantees from the Cayman Islands or Barbados, as
applicable, for all taxes levied upon profits, income, gains and appreciation
that are valid through September 30, 2003, March 10, 2012 and May 19, 2003,
respectively.
UNITED STATES EXCISE TAXES. Foreign insurance and reinsurance companies
such as NAICO Indemnity and Chandler Barbados are subject to a 1% United
States
excise tax on reinsurance premiums received with respect to reinsured risks
located in the United States and a 4% United States excise tax on direct
premiums written and received with respect to insured risks located in the
United States.
UNITED STATES TAXATION OF SHAREHOLDERS. Under Section 951(b) of the
Internal Revenue Code of 1986 as amended (the "Code"), any United States
corporation, citizen, resident or other United States person who owns,
directly
or indirectly, or is considered to own (by application of the rules of
constructive ownership set forth in Code Section 958(b), generally applying to
family members, partnerships, estates, trusts or controlled corporations) 10%
or more of the total combined voting power of all classes of voting stock of
the Company will be considered a "United States shareholder" for United States
income tax purposes. If such "United States shareholders" collectively own
more than 25% of the value or combined voting power of all classes of the
Company's stock for an uninterrupted period of 30 days or more during any
taxable year, each "United States shareholder" will be required to include in
his gross income his share of the Company's "subpart F insurance income,"
whether or not this income is distributed to him. The Company's "subpart F
insurance income" would include, among other items, income derived from the
reinsurance of risks located outside the Company's country of incorporation.
In addition, if such "United States shareholders" collectively own more than
50% of the Company's stock for an uninterrupted period of 30 days or more
during any taxable year, each "United States shareholder" will be required to
include in gross income the Company's "other subpart F income" and amounts
under Section 956, whether or not such income and amounts are distributed to
him. The Company's Section 956 amounts would include certain amounts invested
by the Company in U.S. property. The Company's "other subpart F income" would
include most interest and other investment income and gains. See "SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - Possible Change in
Control".
Currently, M. J. Moroun, individually and through CenTra, Inc. ("CenTra")
and their affiliates (the "Moroun Group"), beneficially owns roughly 45% of
the
outstanding voting stock of the Company. See "SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT - Other Matters Regarding Beneficial
Ownership". The Company is not aware of any other U.S. shareholders who
currently own (directly or indirectly) 10% or more of the Company's stock.
Assuming that the Moroun Group is considered to own the value and voting power
of shares that it owns directly or indirectly, notwithstanding certain
temporary restraints on its right to vote such stock, the Company will be
treated as a controlled foreign corporation ("CFC"), at least with respect to
its "subpart F insurance income", and possibly with respect to its "other
subpart F income" and Section 956 amounts, and the Moroun Group and any other
"United States shareholders" may be subject to tax on the Company's "subpart F
insurance income" and possibly also its "other subpart F income" and Section
956 amounts, in 1992 and subsequent periods.
<PAGE>
PAGE
12
Under Section 953(c) of the Code, if U.S. persons indirectly own (i.e.,
through ownership of the Company) 25% or more of the total combined voting
power of all classes of Chandler Barbados' stock entitled to vote or 25% or
more of the total value of Chandler Barbados' stock, then each such person is
required to include in his gross income a portion of any insurance income of
Chandler Barbados attributable to a policy of insurance or reinsurance with
respect to which the person insured (directly or indirectly) is a related
person to a shareholder in Chandler Barbados ("related person insurance
income"
or "RPII"). Under these rules, all U.S. persons who own stock in the Company
(including Chandler's U.S. subsidiaries) would generally be required, subject
to the exception discussed hereinafter, to include in their gross incomes a
portion of the RPII received by Chandler Barbados from NAICO. However,
related
person insurance income of Chandler Barbados need not be included in the
income
of a U.S. person who is not a "United States shareholder," as defined above,
if, at all times during Chandler Barbados' taxable year, less than 20% of the
total combined voting power of all classes of stock of Chandler Barbados and
less than 20% of the total value of Chandler Barbados is owned (directly or
indirectly) by persons who are (directly or indirectly) insured under any
policy of insurance or reinsurance issued by Chandler Barbados, or who are
related persons to any such person.
In connection with its examination of the 1992 federal income tax return
of the Company's wholly owned subsidiary Chandler (U.S.A.), Inc. ("Chandler
USA"), the Internal Revenue Service (the "IRS") contended that Chandler
Barbados did not qualify, for its 1992 and subsequent taxable years, for the
exception to the inclusion of RPII for all U.S. persons who hold the Company's
stock, because the Company owns more than 20% of the voting power and value of
Chandler Barbados, and the Company is a related party to NAICO, which
purchases
reinsurance from Chandler Barbados. However, Chandler USA believed, and
asserted to the IRS that U.S. persons who hold less than 5.5% of the stock of
the Company should not be required to include any RPII of Chandler Barbados in
their incomes. The IRS agreed with Chandler USA's position on this issue, and
a formal closing agreement was executed in 1996.
Under Section 956A, which was repealed effective January 1, 1997, if the
Company or any foreign subsidiary is a CFC, each "United States shareholder"
(as defined previously) of the Company or such foreign subsidiary will be
required to include in his gross income an amount determined with respect to
the Company's or the foreign subsidiary's "excess passive assets" for the
taxable year. Generally, any amount of "passive assets" in excess of 25% of
the Company's or a foreign subsidiary's total assets will be considered
"excess
passive assets." "Passive assets" are assets that produce, or are held for
the
production of, passive income (e.g., dividends, interest, rents, and
royalties). "Passive income" does not include income "derived in the active
conduct of an insurance business by a corporation which is predominantly
engaged in an insurance business and which would be subject to tax under
Subchapter L (relating to insurance companies) if it were a domestic
corporation." In addition, certain "look-through" rules treat a foreign
corporation that owns (directly or indirectly) at least 25% by value of the
stock of another corporation as if the foreign corporation held its
proportionate share of the assets of the other corporation and received
directly its proportionate share of the income of the other corporation.
Management believes that no amount is includible in the income of a "United
States shareholder" under Section 956A. However, there can be no assurance
that the IRS will not successfully challenge this position.
Under Section 552 of the Code, the Company or any foreign subsidiary may
be classified as a foreign personal holding company ("FPHC") if (i) at least
60% (or in the case of any corporation that has been classified as an FPHC in
a
previous year, 50%) of its gross income for the taxable year is FPHC income
and
(ii) at any time during the taxable year more than 50% of the total voting
power or the total value of the stock of such company is owned (directly or
indirectly) by or for not more than five individuals who are citizens or
residents of the United States. FPHC income generally includes interest,
royalties, annuities, gains from the sale or exchange of stock or securities
and dividends, other than the non-FPHC portion of dividends. For purposes of
determining a person's stock ownership, stock owned by a corporation will be
considered to be owned proportionately by its shareholders. Hence, each
ultimate individual owner of the Company will be treated as owning a portion
of
the stock of the Company determined by looking through all intermediate
ownership entities. If the Company or any foreign subsidiary is classified as
an FPHC by application of the above-stated rules, then each U.S. person owning
stock in the Company or such foreign subsidiary will be required to include in
his gross income, as a dividend, for the taxable year an amount equal to his
share of the undistributed FPHC income of such corporation. Although
management has concluded that the Company and its foreign subsidiaries satisfy
the 50% ownership test, none of the foreign subsidiaries satisfy the 60% gross
income test, and the Company did not receive any material income for its
taxable years ending in 1995, 1996 and 1997.
Under Section 542 of the Code, the Company and each of its subsidiaries
may be classified as a personal holding company ("PHC"). A corporation will
be
classified as a PHC if (i) it is not an FPHC or a passive foreign investment
company ("PFIC"); (ii) at least 60% of its adjusted ordinary gross income (as
defined in Section 543) for the taxable year is PHC income; (e.g., dividends,
interest, annuities, royalties and rents) and (iii) at any time during the
last
half of the taxable year more than 50% in value of its outstanding stock is
owned (directly or indirectly) by or for not more than five individuals. In
the case of an affiliated group filing or required to file a consolidated U.S.
income tax return, the 60% test is generally applied to the affiliated group
as
a whole and no members of the affiliated group will be considered to satisfy
the 60% test unless the affiliated group meets the 60% test. If either the
Company or any of its subsidiaries is classified as a PHC, such PHC will be
subject to a PHC tax equal to 39.6% of the undistributed PHC income. Based on
the proportion of the gross income of the Company and each of its subsidiaries
that consisted of PHC income, the Company's management believes that neither
the Company nor any of its subsidiaries constituted a PHC for its taxable
years
ending in 1995, 1996 and 1997.
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13
UNITED STATES INCOME TAXATION OF THE COMPANY AND ITS SUBSIDIARIES.
Chandler Barbados is organized and endeavors to conduct its business from
Barbados and not within the United States. Accordingly, Chandler Barbados
does
not presently file United States income tax returns. Pursuant to United
States
Treasury Regulations, Chandler Barbados has filed, and will continue to file,
protective returns for its taxable years ending after July 31, 1990 indicating
that it is not engaged in business in the United States and that even if it is
so engaged it does not conduct such business through a permanent establishment
in the United States so that, under the U.S.-Barbados Income Tax Treaty it is
not subject to United States Federal income tax on its insurance income.
However, since neither the Code, court decisions nor regulations definitively
describe activities that constitute being engaged in a trade or business in
the
United States, there can be no assurance that the IRS will not successfully
contend that Chandler Barbados is engaged in a trade or business in the United
States through a permanent establishment on the basis that the Company's
affiliates or its shareholders, employees, officers or directors are agents of
Chandler Barbados in the United States. If Chandler Barbados is deemed to be
so engaged, it will be subject to United States income tax on its income that
is effectively connected with the conduct of that trade or business. Such
income tax, if imposed, would be computed on the effectively connected income
in a manner comparable to the computation of income of a domestic insurance
corporation, except that (i) Chandler Barbados may be subject to an additional
"branch profits tax" on deemed dividend equivalents and interest payments, and
(ii) Chandler Barbados' applicable deductions and credits will be disallowed
if
it fails to file a return for its taxable years ended prior to July 31, 1990
or
to timely file the protective United States income tax return described above
for taxable years ended after July 31, 1990. Chandler Barbados has not filed
a
return for the taxable years ended prior to July 31, 1990.
Regardless of whether Chandler Barbados is considered to be engaged in a
trade or business in the United States, it is subject to United States income
tax on certain "fixed or determinable annual or periodic gains, profits and
income" derived from sources within the United States as enumerated in Section
881(a) of the Code, including dividends and related party interest but
generally excluding interest from unrelated parties. This tax is imposed on
the gross amount of such income, generally at a fixed 30% rate but, in the
case
of dividends from Chandler USA to Chandler Barbados, at a 5% rate. The United
States person responsible for payment of such items of income to Chandler
Barbados is obligated to withhold this tax before payment is made to Chandler
Barbados.
NAICO is subject to tax on its taxable income under subchapter L of the
Code. Reinsurance premiums paid by NAICO are generally deductible for this
purpose. The IRS in Revenue Ruling 77-316 has taken the position that where a
United States parent corporation and its domestic subsidiaries insure their
risks with an offshore subsidiary, the premiums paid to the offshore
corporation are not deductible by the United States corporation and, if paid
by
the United States subsidiaries, are constructive distributions to the United
States parent. Certain court cases have supported the IRS's position that
premiums paid by a parent to its subsidiary are not deductible. The IRS could
argue that premiums paid to Chandler Barbados should not be deductible and
that
instead, to the extent of NAICO's earnings and profits, they should be
characterized as dividends subject to a 5% withholding tax.
The IRS has the authority under Section 482 of the Code to reallocate
income, deductions and credits among related taxpayers. If the IRS were
successfully to contend that a portion of the premiums paid by NAICO to
Chandler Barbados exceeded an arm's length premium, such excess amount would
probably be characterized as a distribution by Chandler USA to Chandler
Barbados with the result that the United States consolidated group would not
be
permitted a deduction, and Chandler Barbados would be subject to a 5%
withholding tax with respect to such excess amount.
Any determination that Chandler Barbados was engaged in business in the
United States, any disallowance of deductions for most or all of the
reinsurance premiums paid by NAICO to Chandler Barbados or any substantial
reallocation of income from Chandler Barbados to NAICO would cause
substantially all of the Company's consolidated net income before income taxes
to be subject to United States income tax with credit given for income and
excise taxes previously paid.
Between January 1, 1987 and March 31, 1988, the Company performed the
reinsurance functions currently performed by Chandler Barbados. The above
description of the potential United States income taxation of Chandler
Barbados
is equally applicable to the activities of the Company during that period,
except that any U.S. withholding tax requirements would be at a rate of 30%
rather than a 5% rate.
On October 25, 1994 the IRS proposed increases in federal income tax and
the imposition of federal withholding tax and penalties payable by Chandler
USA
for calendar years 1989 through 1992 in the approximate amount of $2.5 million
plus interest. With the exception of the increase in Chandler USA's income
for
a proposed amount of subpart F income (see "United States Taxation of
Shareholders") the remaining proposed increase in income tax arose from the
disallowance of deductions for certain expenses (primarily litigation costs -
see "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF
OPERATIONS") incurred by Chandler USA in calendar years 1991 and 1992, and the
subsequent disallowance of a net operating loss carryback to calendar years
1989 through 1991. The proposed withholding tax assessment arose out of an
assertion by the IRS that certain of the non-deductible expenses were incurred
for the benefit of the Company, that they should be treated as a deemed
distribution by Chandler USA to the Company, and as such should be subject to
a
30% U.S. withholding tax. Chandler USA disagreed with the proposed
adjustments
and filed a written protest of the proposed adjustments on December 23, 1994.
During the fourth quarter of 1995, after numerous discussions and
preliminary consensus with the IRS, Chandler USA made a provision for possible
assessments of additional taxes through 1992 and additional taxes attributable
to amended returns for 1993 and 1994 in the amount of $536,000. During 1996,
the IRS and Chandler USA executed a formal closing agreement, Chandler USA
paid
the taxes for the open tax years (1989 through 1994) and the IRS closed its
examination.
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14
During 1996, the IRS conducted a field examination of the U.S. Federal
income tax returns of Chandler USA and its wholly owned subsidiaries for the
years 1993 and 1994. The IRS completed the examination in the fourth quarter
of 1996 and there were no proposed adjustments to tax liabilities.
ITEM 2. PROPERTIES
The Company's principal office is located on the 5th Floor, Anderson
Square in Grand Cayman, Cayman Islands, B.W.I. Chandler Barbados' principal
office is located in the Stevmar House, Rockley, Christ Church, Barbados. The
Company and Chandler Barbados have no offices in the United States.
The Company's United States-based subsidiaries own and occupy three
office
buildings with approximately 81,000 square feet of usable space at the home
office in Chandler, Oklahoma. The Company's subsidiaries also lease
approximately 10,600 square feet in the aggregate for its branch offices. The
Company believes such space will suffice for the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
CENTRA LITIGATION -- GENERAL BACKGROUND
CenTra is a Detroit-based holding company primarily engaged in the
trucking industry. Beginning in 1987, NAICO insured CenTra's automobile
liability, general liability and workers compensation risks through
reinsurance
arrangements involving DuraRock Underwriters, Ltd. ("DuraRock"), a Barbados
company and an affiliate of CenTra, its predecessor Can-Am Underwriters, Ltd.
("Can-Am") and Chandler Barbados. In addition to the insurance arrangements,
CenTra and its affiliates have been significant shareholders in the Company
(holding approximately 22.7% of the Company's common stock at July 1, 1992).
See "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT". Three
present or former executive officers of CenTra, Norman E. Harned, Ronald W.
Lech and M. J. Moroun, are directors of the Company. See "DIRECTORS AND
EXECUTIVE OFFICERS OF THE REGISTRANT".
Beginning in 1992, the relationships between the Company and CenTra
deteriorated largely due to differences about the CenTra insurance program,
CenTra's failure to make timely premium payments and CenTra's role in an
anticipated management-led tender offer. In an apparent attempt to block the
tender offer and seize control of the Company, CenTra began, on July 1, 1992,
a
series of common stock purchases and offers to purchase that would, over the
following two weeks, place almost one-half of the Company's common stock with
CenTra and its affiliates. On July 1 and 2, 1992, CenTra made an offer to
Chandler USA, an indirect subsidiary of the Company, to purchase 1,117,679
common shares. These common shares were either owned by Chandler USA (567,350
common shares) or pledged to a subsidiary and owned by Cactus Southwest Corp.
(169,858 common shares) or the Universal Insurance Group (380,471 common
shares). Chandler USA declined the offer. On July 2, 1992, NAICO and NAICO
Indemnity canceled the CenTra insurance policies for non-payment of premiums
effective September 5, 1992. On July 2, 1992, CenTra made an offer to Cactus
Southwest Corp. to purchase 169,858 common shares owned by it but pledged to
the Chandler USA subsidiary to collateralize certain receivables. On July 7,
1992, the Nebraska Department of Insurance (the "Department") ordered CenTra
to
cease and desist purchases of the Company's common shares. On July 9, 1992,
M.J. Moroun withdrew CenTra's prior offer to Cactus Southwest Corp. and
offered
to purchase the same common shares himself. At the same time, he began
purchasing common shares in the open market. On July 10, 1992, the Department
ordered CenTra and its affiliates and Messrs. M.J. Moroun, Harned and Lech to
cease and desist purchases of the Company's common shares. On the same date,
M.J. Moroun made an offer to the Universal Insurance Group to purchase 380,471
common shares owned by it but pledged to the Chandler USA subsidiary, and M.J.
Moroun made further open market purchases. On July 11, 1992, M.J. Moroun paid
$100,000 to the Universal Insurance Group for an irrevocable proxy and
contracted with it for the purchase of its pledged common shares. On July 12,
1992, M.J. Moroun contracted with Cactus Southwest Corp. for the purchase of
its pledged common shares. On July 13, 1992, further open market purchases
were made in the name of Can-Am, a not-yet-formed Bahamian affiliate of
CenTra.
Also on July 13, 1992, the District Court for Lancaster County, Nebraska
entered a temporary restraining order against CenTra, Messrs. M.J. Moroun,
Harned and Lech, John and Jane Doe, XYZ Corporation, and their affiliates
known
and unknown, prohibiting further purchases. On July 14 and 17, 1992, the
stock
brokerage firm through which the open market purchases were made purportedly
substituted Can-Am for M.J. Moroun as the purchaser on the July 9 and 10 sales
confirmations. At some time after July 13, 1992, M.J. Moroun assigned his
rights to purchase the pledged shares of the Universal Insurance Group and
Cactus Southwest Corp. to Can-Am; neither CenTra nor Can-Am now claim
ownership
or any interest in the shares. During the second quarter of 1997, ownership
of
380,471 shares was transferred to a Chandler subsidiary as payment for one of
the agent's debts. In December 1997, 114,146 shares were transferred to a
Chandler subsidiary and the balance of the pledged shares were transferred to
unaffiliated persons and entities. These transactions had the effect of
canceling the debts secured by the shares. The shares are held as a reduction
of shareholders' equity.
Through the above transactions, CenTra and its affiliates acquired, or
contracted to acquire, an additional 26.5% of the Company's common stock,
bringing their total claimed stock ownership to 49.2% in July 1992. The
tender
offer, which commenced on July 9, 1992 without knowledge of the open market
purchases, was withdrawn on July 23, 1992. See "SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT" for further information about the stock
ownership of CenTra and its affiliates. As these developments unfolded,
CenTra
or its affiliates or both initiated litigation in Oklahoma, Arkansas and
Michigan, and an administrative proceeding in Nebraska, the domicile of NAICO.
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15
CENTRA LITIGATION -- OKLAHOMA
BACKGROUND OF OKLAHOMA LAWSUIT. On July 16, 1992, CenTra and Messrs.
M.J.
Moroun, Lech and Harned filed a lawsuit in the United States District Court
for
the Western District of Oklahoma against the Company, the other corporations
participating in the tender offer, and various individuals including certain
officers and employees of the Company and its subsidiaries and the remaining
directors of the Company, except Mr. Paul Maestri. The lawsuit sought
declaratory and injunctive relief to prevent the tender offer alleging
breaches
of fiduciary and other duties and violations of the federal securities laws.
After the tender offer was withdrawn, the plaintiffs amended their complaint
on
August 5, 1992, alleging breaches of fiduciary and other duties by commencing
the tender offer and violations of federal securities laws in the tender offer
and in certain transactions since 1988. The Company and the other defendants
denied any breaches of duty or violations of law and the Company filed various
counterclaims against CenTra and various affiliates alleging breaches of
fiduciary duties and violations of federal securities laws in their attempts
to
seize control of the Company through the July 1992 stock purchases, and sought
damages, costs and attorney fees. The Company also asserted a counterclaim
against M.J. Moroun, individually, based upon his alleged violation of Section
16(b) of the Securities Exchange Act of 1934 regarding "short swing" profits.
On January 6, 1993, the plaintiffs filed a second amended complaint (i)
asserting violations of federal securities laws and a breach of contract claim
in a 1988 stock purchase; (ii) asking the court to declare invalid and
unenforceable a corporate resolution based on Article XI of the Company's
Articles of Association (prohibiting certain business combinations) that
prohibits Can-Am and its affiliates (including CenTra) from voting their
shares
of the Company's common stock; and (iii) asserting 13 derivative claims for
fiduciary misconduct, unjust enrichment, fraud and/or breach of contract in
the
tender offer, for management bonuses in 1988 and 1989, in the Company's
purchase of three management-related agencies in 1988, and for assorted
improper personal benefits. All of these derivative claims seek unspecified
damages, restitution and/or injunctive relief on behalf of the Company,
including punitive damages, attorneys' fees and costs. In 1994 the plaintiffs
made a request to file a third amended complaint. The Court denied that
request.
A three member committee ("Special Committee"), who are on the board of
directors of NAICO and are not named in the lawsuits, investigated the
derivative claims. The Special Committee concluded the Company should take no
action against the individual defendants regarding the claims relating to the
tender offer, the management bonuses and the agency purchases. As to the
allegedly improper personal benefits, the Special Committee found that some
were ordinary and necessary business expenses while others were not. The
Special Committee recommended that the recipients reimburse the Company or the
affected subsidiaries for all improper personal benefits, the full value of
which was $135,000. The respective Boards of Directors of the Company and the
affected subsidiaries accepted the report and recommendations of the Special
Committee and retained special legal counsel to implement the recommendations
of the Special Committee. Messrs. M.J. Moroun, Lech and Harned dissented.
On July 20, 1992, CenTra sued NAICO in the Circuit Court of Macomb
County,
Michigan alleging that NAICO and certain officers and directors wrongfully
canceled insurance policies issued to CenTra. CenTra claimed that the
cancellation was retaliation for CenTra's decision not to participate in the
tender offer, requested that the policies be reinstated, and sought monetary
damages for the wrongful cancellation. The case was removed to the U.S.
District Court for the Eastern District of Michigan. NAICO replied that the
cancellation was proper based on CenTra's continuing failure to pay premiums.
After two extensions of the cancellation date, the policies were canceled
effective on September 5, 1992 after CenTra acquired replacement insurance.
On
August 26, 1992, CenTra deposited $700,000 with the court clerk under court
order as security for premiums due under the NAICO policies. On October 13,
1992, the court granted defendants' motion to transfer the action to the U.S.
District Court for the Western District of Oklahoma. On January 27, 1993,
plaintiff filed an application in the Court of Appeals for the Sixth Circuit
contending that the district court abused its discretion by transferring the
case to Oklahoma. The application was denied. CenTra then filed a motion in
the U.S. District Court in Oklahoma to transfer the case to Michigan. The
U.S.
District Court in Oklahoma retained jurisdiction of the case. NAICO filed a
claim seeking payment of the unpaid premiums and contended that the
cancellations were proper and denied that CenTra suffered any damages as a
result of the cancellations, or any action taken by NAICO associated with the
cancellations.
OKLAHOMA JUDGMENTS - APRIL 22, 1997, MARCH 10, 1998. On February 13,
1997, trial commenced in the United States District Court in Oklahoma City,
Oklahoma (the "Oklahoma Federal Court") in the consolidated cases involving
CenTra and certain of its affiliates, officers and directors (the "CenTra
Group") and the Company and certain of its affiliates, officers and directors.
On April 1, 1997, at the close of all of the evidence, the Court entered
judgment in favor of NAICO on CenTra's claims for alleged wrongful
cancellation
of CenTra's insurance with NAICO and the affiliate in 1992. See CenTra
Litigation - Other. The remaining issues were submitted to a jury.
On April 9, 1997, the jury returned verdicts on all claims. On April 22,
1997, the Oklahoma Federal Court entered judgments on all verdicts returned.
One judgment against the Company requires the CenTra Group to return stock it
purchased in 1990 to the Company in return for a payment of $5,099,133 from
the
Company. Another judgment was against both the Company and its affiliate
Chandler Barbados and in favor of CenTra and its affiliate Ammex, Inc. Based
upon an alleged breach of a stock purchase agreement in 1988, CenTra and Ammex
were awarded $6,882,500. Both judgments related to alleged failures by the
Company to adequately disclose the fact that ownership of the Company's stock
may be subject to regulation by the Nebraska Insurance Department under
certain
circumstances. The jury also found in favor of CenTra and against certain
officers and/or directors of the Company on the securities claims relating to
CenTra's 1990 purchases and the failure to disclose the application of
Nebraska insurance law, but awarded damages of $1 against each individual
defendant on those claims. On
<PAGE>
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16
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. 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.
On other claims asserted by the CenTra Group, the jury found in favor of
the Company and/or the individual defendants. The jury also found in favor of
NAICO and NAICO Indemnity on their counterclaims for CenTra's failure to pay
insurance premiums in the sum of $788,625 and further upheld a resolution
adopted by the Chandler Board of Directors in August 1992 pursuant to Article
XI of the Company's Articles of Association preventing CenTra and its
affiliates from voting their Chandler stock as a result of purchases made by
the CenTra Group in July 1992 as part of its efforts to acquire control of
Chandler.
The jury found in favor of CenTra on the Company's claim against CenTra
for breach of a standstill agreement contained in a 1988 stock exchange
agreement. The jury denied the Company's claim against Messrs. Harned, Lech
and Moroun based upon their alleged breach of fiduciary duty as directors.
The
jury also denied the Company's claim against Mr. Moroun individually for
violation of Section 16(b) of the Securities Exchange Act of 1934 regarding
short swing profits.
Several post-trial motions were filed by all parties relating to the
judgments and prejudgment interest. The Oklahoma Federal Court ordered that
additional motions for costs and attorney fees be filed within 20 days
following rulings on these motions. However, on October 11, 1997 CenTra filed
motions for costs and attorneys fees totaling $4.7 million. The Company
responded by contending that the motions were filed prematurely and are, in
any
event, without merit.
As a result of the April 22, 1997 judgments, the Company recorded a net
charge for the litigation matters described above during the first quarter of
1997 totaling approximately $8.3 million ($8.5 million including provision for
federal income tax). In addition, the Company recorded the return of 517,500
shares of the Company's stock in conjunction with the stock rescission
judgment
as a decrease to shareholders' equity in the amount of approximately $4.9
million with the remaining amount included in the charge for litigation
matters. The charge includes approximately $4.6 million as an estimate of
interest, costs and related attorney fees. The charge includes an estimated
recovery of $2.7 million from the Company's directors and officers policy
insurer for costs associated with the defense and litigation of these matters.
The Company is entitled to a total of $5 million under the applicable
insurance
policy. Some amounts have been previously paid without dispute and the
Company
is negotiating with the insurer for payment of the policy balance. The
Company
could recover the remaining policy limits or could compromise its claim, and
could incur significant costs in either case. The estimated insurance
recovery
is based upon these variable factors. The charge also includes the amount of
judgments in favor of Chandler USA on the derivative claims discussed above.
Except for the recovery of a portion of the litigation costs from the
Company's
directors and officers policy insurer, no provision has been made in the
accompanying consolidated financial statements related to the advancement of
litigation expenses to certain defendants. See "CERTAIN RELATIONSHIPS AND
RELATED TRANSACTIONS - Advancement of Litigation Expenses".
On March 10, 1998, the Oklahoma Federal Court disposed of all post-trial
motions filed by the parties. The parties had asked the Oklahoma Federal
Court
to vacate or modify judgments unfavorable to them and requested the Oklahoma
Federal Court to award prejudgment interest. The Oklahoma Federal Court
overruled all pending motions except a motion by the Company and Chandler
Barbados to require CenTra and its affiliates to deliver 1,142,625 Shares of
Chandler common stock they own or control upon payment of the $6,882,500
judgment which was entered in CenTra's favor in April 1997. The Company has
recorded the return of 1,142,625 shares of the Company's stock in conjunction
with the order as a decrease to shareholders' equity as of December 31, 1997,
and reduced the previous first quarter of 1997 net charge for litigation
matters by $6,882,500. The CenTra parties were directed to deliver the shares
upon payment of the judgment. CenTra's pending motion for an award of costs
and attorney fees was stricken and all parties were granted leave to file such
motions within 20 days of March 10, 1998. On March 16, 1998 CenTra and its
affiliates filed such motions seeking an award of costs and attorney fees
totaling approximately $4.7 million. All parties may appeal any or all of the
orders of the Oklahoma Federal Court. On March 23, 1998, CenTra and its
affiliates filed a formal notice of intent to appeal certain orders of the
Oklahoma Federal Court but have not yet stated specifically the claims or
issues they or any of them will appeal.
Because all shares of the Company's stock owned by CenTra and its
affiliates are held by the U.S. District Court for the District of Nebraska
("Nebraska Court") it is unclear when or if CenTra and its affiliates will be
able to comply with the Oklahoma Federal Court's order. The Company believes
that it is not required to pay the judgments until CenTra and its affiliates
can deliver the shares to the Company. See "CenTra Litigation - Nebraska".
The ultimate actual amounts resulting from potential motions for the
award
of costs and attorney fees plus matters related to potential appeals by the
parties could result in amounts significantly different from the Company's
estimates, and could have a material adverse effect on the Company and could
negatively impact future earnings.
On April 28, 1997, the Company's Board of Directors appointed a Committee
of the Board (the "Committee") to deal with all matters arising from the
Oklahoma litigation. The Committee was delegated all authority of the Board
on
these issues. The members of the Committee are Messrs. Jacoby, Maestri and
Davis, all of whom are non-parties to the CenTra litigation. The Committee
has
retained independent counsel. The individual members of the Committee review
issues relating to litigation strategy, officer and director indemnification,
and claims made under the Company's director and officer liability insurance
policy on a regular basis in conjunction with a similar committee composed of
Chandler USA directors. The Committee conducts its meetings outside the
United
States, but participates in telephone briefings and discussions at least twice
monthly.
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17
All implications of the Oklahoma Federal Court's ruling have not been
fully evaluated by the Company. These issues are being studied by the
Company's management and the Committee. In the event that the Company should
decide to appeal, it may be required to post a supersedeas bond or bonds to
suspend execution of any judgments against it. The Company believes that if
it
elects to pay the judgments, the shares owned by CenTra or its affiliates
which
are the subject of the judgment must be returned to the Company unless CenTra
appeals and takes appropriate action to supercede the judgments, or the
Nebraska Court does not release the shares.
The Company's management believes that adequate financial resources are
available to post a supersedeas bond or to pay the judgments. As a holding
company, the Company 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.
See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF
OPERATIONS - Liquidity and Capital Resources". A reduction in the amount of
invested assets, or an increase in borrowings resulting from potential payment
of these judgments would reduce investment earnings or increase operating
expenses in future periods.
Chandler USA is the judgment creditor in connection with derivative claim
judgments against certain Chandler officers and directors. Chandler USA's
Special Litigation Committee is considering the course of action Chandler USA
should take with regard to collection of those judgments.
CENTRA LITIGATION -- NEBRASKA
ADMINISTRATIVE. NAICO, which is domiciled in Nebraska, is regulated by
the Nebraska Department of Insurance (the "Department"). The Department
requires a Form A application and prior approval by the Department from anyone
seeking to acquire control, directly or indirectly, of an insurance company
regulated by the Department. CenTra, Can-Am and their affiliates filed a Form
A application with the Department to which the Company and certain of its
affiliates objected. See "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT". On October 28, 1992, the Department denied CenTra's Form A
application. The Department found that (i) the financial condition of the
CenTra Group might jeopardize the financial stability of NAICO or prejudice
the
interests of policyholders; (ii) the competence, experience and integrity of
the CenTra Group is such that it would not be in the best interests of
policyholders or NAICO or the public for the CenTra Group to control NAICO;
and
(iii) the acquisition is likely to be hazardous or prejudicial to the public.
The CenTra Group appealed the Department's order to the Lancaster County
District Court for the State of Nebraska ("District Court"). The District
Court affirmed the Department's order on September 21, 1993. On December 1,
1995 the Nebraska Supreme Court affirmed the Department and the District Court
decisions. On May 13, 1996 the U.S. Supreme Court denied the CenTra Group's
Petition for Writ of Certiorari, thereby declining to review the decision of
the Nebraska Supreme Court.
NEBRASKA COURT ACTION. On October 6, 1995 Agnes Anne Moroun, sister of
M.J. Moroun, purported to acquire 1,441,000 shares of the voting stock of the
Company (the "Shares") from Can-Am Investments, Ltd., an affiliate of three of
the Company's directors, M.J. Moroun, Norman E. Harned, and Ronald W. Lech.
In
response to that action, NAICO filed an action on October 11, 1995 in the
District Court seeking an order sequestering the Shares based upon alleged
violations of the Nebraska Holding Company Systems Act and orders of the
Nebraska Department of Insurance. NAICO also sought a temporary order
enjoining further transfers of the Shares and an order requiring the custodian
of the Shares, Dean Witter, to deliver them to the court. Agnes Anne Moroun,
M.J. Moroun, Norman E. Harned, and others removed the action to the Nebraska
Court on October 17, 1995. The Nebraska Department of Insurance intervened on
that same date requesting relief substantially similar to that requested by
NAICO. The Honorable Warren K. Urbom conducted a hearing on October 18, 1995
and on October 30, 1995 granted the relief requested by NAICO. On October 31,
1995 the order was amended and was extended to 700 shares held by Can-Am
Investments, Ltd. and was extended to include the CenTra Group's claim to
rights to acquire stock. Dean Witter was directed to cause share certificates
to be issued and delivered to the Clerk of the Nebraska Court. On November 8,
1995 the share certificates were issued listing Can-Am Investments, Ltd. as
the
shareholder of 1,441,700 shares pursuant to the order of the Nebraska Court.
On November 2, 1995, Agnes Anne Moroun and the other defendants filed
responsive pleadings and counterclaims against NAICO and the Director of
Insurance of the State of Nebraska ("Insurance Director"). The counterclaims
sought declaratory relief confirming the validity of the purported October 6,
1995 transfer of the Shares and that the Insurance Director and the courts of
the State of Nebraska are without authority to sequester the Shares. The
counterclaims also seek a judgment determining that NAICO's current management
controls the Company without the approval of the Insurance Director and
incidental relief. The Nebraska Court ruled in favor of NAICO on the
counterclaims.
On March 25, 1997 the Nebraska Court, pursuant to the Nebraska Insurance
Holding Company Systems Act, ordered CenTra and certain of its affiliates to
divest all Chandler shares owned by them, regardless of when purchased. The
CenTra defendants own or control 3,133,450 Chandler shares. All such shares
are currently in the possession of the Nebraska Court pursuant to the 1995 and
1997 orders of the Nebraska Court (including the shares subject to the
Oklahoma
Federal Court stock rescission judgments). CenTra's shares represent
approximately 45.1% of the outstanding stock (including the shares subject to
the Oklahoma Federal Court stock rescission judgments and the stock held by
subsidiary). The Nebraska Court directed NAICO, the CenTra defendants and the
Nebraska Insurance Department to submit proposals to the Nebraska Court by
April 21, 1997 for the "orderly divestiture and disposition of the stock". A
hearing would then be scheduled to consider the proposals.
<PAGE>
PAGE
18
CenTra has subsequently appealed the March 25, 1997 order of the Nebraska
Court to the United States Court of Appeals for the Eighth Circuit where the
appeal is now pending. Oral argument is currently scheduled for April 1998.
CenTra's appeal of this order has resulted in a delay of the deadlines for
submitting the proposals and no new submission date has been set at this time.
On October 7, 1997 the Honorable Warren K. Urbom, U.S. District Judge for the
Nebraska Court, ordered CenTra, M.J. Moroun and others to deliver into the
registry of the Nebraska Court by November 6, 1997 all shares of Chandler
stock
owned or controlled by them or their affiliates not previously tendered, to
await the outcome of the appeal of his divestiture order. CenTra requested a
stay of that order. The stay was denied by Judge Urbom and CenTra was again
ordered to deliver their shares to the Nebraska Court, this time by January
12,
1998. CenTra appealed that order to the U.S. Court of Appeals for the Eighth
Circuit, which affirmed Judge Urbom's order. On February 9, 1998 CenTra
deposited an additional 1,691,750 shares with the Nebraska Court. Because of
the uncertainty of the outcome of CenTra's appeal of the Nebraska Court's
orders, and until the final proposals are submitted and accepted, the Company
is unable to predict the effect of the divestiture order on the rights,
limitations or other regulation of ownership of the stock of any existing or
prospective holders of the Company's common stock, or the effect on the market
price of the Company's stock.
The impact of the March 10, 1998 ruling of the Oklahoma Federal Court
(See
CenTra Litigation - Oklahoma) upon the divestiture order is currently unclear.
On March 27, 1997 the Nebraska Court declined to exercise jurisdiction
over 550,329 shares of Chandler stock held as security by Chandler
subsidiaries
for debts owed by two former agents but in which CenTra claimed to have option
rights. The Nebraska Court's ruling cleared the way for the Company's
subsidiaries to begin the process of disposing of these shares to retire the
agents' debts to the subsidiaries. CenTra did not appeal this order. During
the second quarter of 1997, ownership of 380,471 shares was transferred to a
Chandler subsidiary as payment for one of the agent's debts. In December
1997,
114,146 shares were transferred to a Chandler subsidiary and the balance of
the
pledged shares were transferred to unaffiliated persons and entities. These
transactions had the effect of canceling the debts secured by the shares. The
shares are held as a reduction of shareholders' equity.
CENTRA LITIGATION - OTHER
On September 25, 1997, NAICO learned that several CenTra affiliates had
filed two lawsuits in state court in Macomb County, Michigan against NAICO,
NAICO Indemnity and certain NAICO officers asserting the same claims made and
tried in the Oklahoma lawsuit described above (see CenTra Litigation -
Oklahoma). Those claims were purportedly prosecuted by CenTra on its own
behalf and on behalf of its subsidiaries. The Oklahoma Federal Court entered
a
judgment against CenTra on these claims. The damages sought are unspecified
but the claims are based upon NAICO's cancellation of CenTra's insurance in
1992. NAICO and NAICO Indemnity contend that the Oklahoma Federal Court's
adjudication is conclusive as to all claims. The lawsuits were removed to the
U.S. District Court for the Eastern District of Michigan, Southern Division
("Michigan Federal Court"). NAICO and NAICO Indemnity have filed dispositive
motions which are currently under advisement. On February 28, 1998 the
Michigan Federal Court ordered the lawsuits transferred to the Oklahoma
Federal
Court.
During the first quarter of 1997 the Company concluded an arbitration
proceeding involving DuraRock and recorded approximately $315,000 in
litigation
and settlement expenses related to this matter. Since December 31, 1997, the
Company has also resolved various issues resulting in settlement of litigation
and arbitration proceedings among subsidiaries of the Company and CenTra
affiliates, and has recorded litigation and settlement expenses of
approximately $147,000 in 1997.
At the present time the Company is actively participating in court
proceedings, possible discovery actions and rights of appeal concerning these
various legal proceedings; therefore, the Company is unable to predict the
outcome of such litigation with certainty or the effect of such ongoing
litigation on future operations. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS" and Notes to Consolidated
Financial Statements.
OTHER LITIGATION
The Company 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
Due to the uncertainties created by the 1992 CenTra stock purchases and
related regulatory uncertainties, it is uncertain whether a shareholders
meeting will be held during 1998.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
MARKET
The common shares of the Company trade on The NASDAQ Stock Market under
the symbol: CHANF.
<PAGE>
PAGE
19
The following table sets forth the quarterly high and low closing sales
prices of the Company's common shares, as reported by The NASDAQ Stock Market,
since January 1, 1996.
<TABLE>
<CAPTION>
1997 1996
--------------- ---------------
HIGH LOW HIGH LOW
------ ------ ------ ------
<S> <C> <C> <C> <C>
First Quarter.......... $ 5.94 $ 5.13 $ 6.63 $ 6.00
Second Quarter......... 5.75 4.13 6.75 6.00
Third Quarter.......... 6.00 3.88 6.50 6.00
Fourth Quarter......... 5.75 4.88 6.06 5.50
</TABLE>
The closing market price of the common shares on The NASDAQ Stock Market
on March 20, 1998 was $8.00 per share.
SHAREHOLDERS
As of February 28, 1998, there were 162 shareholders of record and
approximately 359 beneficial holders of the Company's common shares, and the
number of common shares issued was 6,941,708 shares, which includes 494,617
common shares owned by a subsidiary of the registrant which are eligible to
vote, and 1,660,125 common shares which were rescinded through litigation and
are held by a court. See "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT."
The provisions of Article XI of the Company's Articles of Association,
which was adopted by the shareholders in 1988, prohibits business combinations
lacking approval of the Continuing Directors (those not affiliated with a 20%
or more shareholder) or 80% of the shareholders and may result in a
prohibition
against voting such shares held by a shareholder acquiring 20% or more of the
common shares (and its affiliates and associates) if the Continuing Directors
deny approval. In addition to the regulatory oversight of NAICO by the
Nebraska Department of Insurance, the Company is also subject to regulation
under the Nebraska Insurance Holding Company Systems Act (the "Holding Company
Act"). In addition to various reporting requirements imposed on the Company,
the Holding Company Act requires any person who seeks to acquire or exercise
control over NAICO (which is presumed as to any person who owns 10% or more of
the Company's outstanding voting stock) to file and obtain approval of certain
applications with the Nebraska Department of Insurance regarding their current
or proposed ownership of such shares. Non-compliance with the Holding
Company
Act may result in certain civil and criminal penalties or a requirement that
the non-approved owner divest itself of such shares.
DIVIDENDS
The Company has never paid cash dividends on its common shares, and its
current policy is to retain earnings to support its insurance operations. As
a
holding company, the Company depends primarily on share issuances, borrowings
and dividends from its subsidiaries for its cash flow requirements. Any
payment of future dividends will be dependent upon earnings of the Company's
subsidiaries and their ability to pay shareholder dividends therefrom,
financial requirements of the Company and its subsidiaries, business outlook,
and other relevant factors.
A significant portion of the Company's consolidated assets represents
assets of the Company's insurance subsidiaries that may not be transferable to
the holding company in the form of dividends, loans or advances. The Company's
insurance subsidiaries are subject to various state statutory and regulatory
restrictions, generally applicable to each insurance company in its state of
incorporation, which limit the amount of dividends or distributions by an
insurance company to its stockholders. The restrictions are generally based on
certain levels of surplus, operating income and investment income, as
determined under statutory accounting practices.
The Holding Company Act regulates the distribution of dividends and other
payments to the Company by its subsidiaries. Under the applicable Nebraska
statute, the maximum discretionary dividend that may be declared (or
cash/property distribution that may be made) by NAICO is the greater of (i)
the
insurance company's net income (excluding realized capital gains) for the
preceding calendar year plus 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) ten percent of the insurance company's
policyholders' surplus for the preceding calendar year, excluding unrealized
gains. These dividends are further limited by a clause in the Nebraska law
which prohibits an insurer from declaring dividends except out of earned
surplus of the company, as allowed under the Insurance Code.
The payment of cash dividends by Chandler Barbados is limited to its
realized earned surplus and margin of solvency requirements.
Chandler Barbados and NAICO (during ownership by the Company) have not
paid any cash shareholder dividends.
FOREIGN ISSUER
The Cayman Islands currently does not have any restrictions or exchange
controls on the transfer of funds into and out of the Cayman Islands.
Chandler
Barbados is licensed as an "exempt insurance company", and Barbados currently
does not have any restrictions or exchange controls for exempt insurance
companies on the transfer of funds out of Barbados. If in the future the
Company's assets are invested in foreign securities or held in currencies
other
than United States dollars, the Company will be subject to a risk of currency
fluctuations and devaluations. See "BUSINESS--Regulation".
<PAGE>
PAGE
20
All or a substantial portion of the Company's assets are or may be
located
outside the United States. As a result, it may be difficult to obtain
jurisdiction over or to enforce judgments against the Company in any legal
proceeding by the Company's shareholders. Certain remedies available under
United States securities laws may not be allowed in a Cayman Islands or
Barbados court as a violation of their public policy.
The operations of the Company and Chandler Barbados will be conducted in
the Cayman Islands and Barbados, respectively, and may, therefore, be affected
by changes in those governments and other economic and political conditions.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data has been derived from the consolidated
financial statements of the Company and subsidiaries, which appear in Item
14(a). The consolidated balance sheets of the Company and its subsidiaries as
of December 31, 1996 and 1997, and the related consolidated statements of
operations, shareholders' equity and cash flows for each of the three years in
the period ended December 31, 1997, have been audited by Deloitte & Touche,
independent auditors. The selected financial data should be read in
conjunction with "LEGAL PROCEEDINGS", "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS" and the consolidated financial
statements of the Company and the notes thereto appearing in Item 14(a). See
Notes to Consolidated Financial Statements for various litigation and
contingency matters.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- ------------------------------------------------
1993 1994 1995 1996 1997
-------- -------- -------- --------
- --------
(Amounts in thousands except
per share data and percentages)
<S> <C> <C> <C> <C> <C>
OPERATING DATA
Revenues
Net premiums earned........$ 79,300 $ 81,597 $ 81,087 $ 89,286 $
94,679
Net investment income...... 12,087 8,675 8,053 7,339
8,017
Commissions, fees and
other income............. 3,234 2,861 3,095 3,620
2,528
Total revenues................. 94,621 93,133 92,235 100,245
105,224
Operating expenses
Losses and loss
adjustment expenses...... 52,504 55,872 50,543 53,391
57,512
Policy acquisition costs... 25,742 20,372 23,995 32,123
28,145
General and administrative
expenses................. 11,656 12,651 12,822 14,184
13,579
Litigation expenses, net... 2,051 1,921 285 (108)
4,772
Total operating expenses....... 91,953 90,816 87,645 99,590
104,008
Income before income taxes..... 2,668 2,317 4,590 655
1,216
Net income (loss).............. 3,698 2,474 3,778 972
(1,065)
Basic and diluted earnings
(loss) per common
share (4)..................$ 0.53 $ 0.36 $ 0.54 $ 0.14 $
(0.16)
Weighted average common
shares outstanding......... 6,942 6,942 6,942 6,942
6,687
Combined loss and underwriting
expense ratio (1).......... 107% 103% 101% 106% 100%
BALANCE SHEET DATA
Cash and investments...........$146,022 $124,501 $122,561 $119,136 $
125,063
Total assets................... 286,447 261,364 246,949 206,827
210,790
Unpaid losses and loss
adjustment expenses (2).... 179,815 156,060 128,794 79,639
74,929
Notes payable.................. - - 300 4,391
2,796
Litigation liabilities......... - - - -
16,618
Total liabilities (2).......... 218,265 197,905 173,499 134,280
152,455
Stock held by subsidiary,
at cost................... (2,148) (2,148) (2,148) -
(2,487)
Stock rescinded through
litigation................ - - - -
(11,799)
Shareholders' equity........... 68,182 63,459 73,450 72,547
58,335
Book value per share (3)....... 9.82 9.14 10.58 10.45
12.19
- -------------------------------
<FN>
(1) Litigation expenses are not considered underwriting expenses; therefore,
such expenses have been excluded from this ratio. The 1996 underwriting
expense ratio was increased by 4 percentage points by a reinsurance
arbitration adjustment and the termination of relations with the
Company's
former surety bond underwriting manager. See "MANAGEMENT'S DISCUSSION
AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS".
(2) For the years prior to 1994, the Company reclassified the liability NAICO
assumes as a result of participating in various Pools from accrued taxes
and other payables to unpaid losses and loss adjustment expenses.
(3) Based on total common shares outstanding, less stock held by subsidiary
and stock rescinded through litigation. See "LEGAL PROCEEDINGS - CenTra
Litigation - Oklahoma".
(4) The adoption of Statement of Financial Accounting Standard No. 128,
EARNINGS PER SHARE did not have an impact on share and per share
information.
</TABLE>
<PAGE>
PAGE
21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
[References to the "Company" which follow within this Item 7 refer to the
Company and its subsidiaries on a consolidated basis unless otherwise
indicated.]
The long-term success of an insurance company depends on its ability to
carve out markets and maintain a competitive advantage in those markets. Many
factors determine the profitability of an insurance company including rate
competition; the frequency and severity of claims; the cost, availability and
collectibility of reinsurance; interest rates; inflation; general business
conditions; jury awards, court decisions and legislation expanding the extent
of coverage and the amount of compensation due for injuries and losses.
COMPETITION
The property-casualty insurance industry is very competitive. Insurers
compete on the basis of marketing effort, product, price, service and
financial
strength. The Company's competitors range from smaller regional independent
insurance companies to major worldwide insurance companies. Many of the
Company's competitors have substantially greater financial and other
resources,
and some offer a broader variety of coverages than those offered by the
Company.
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 in the industry when excess underwriting capacity exists. The Company
continues to experience pricing competition in certain segments of its
business
as the conditions of heightened price competition and impaired underwriting
performance continue in the industry as a whole.
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 unreported 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 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 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, 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 Chandler Barbados 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 described by state law and are
estimated
based on the same factors generally discussed above, with actuarial input,
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.
The Company's subsidiaries report their reserves on the basis of U.S.
GAAP. NAICO's statutory-based reserves do not differ from its U.S. GAAP
reserves. Neither NAICO nor Chandler Barbados discounts its reserves for
unpaid losses and loss adjustment expenses.
<PAGE>
PAGE
22
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 clean-up and restoration of damage resulting
from sudden and accidental release or discharge of contaminants or other
substances which may be classified as pollutants. NAICO also provides surety
bonds for construction contractors who use or have control of such substances
and for contractors who remove and dispose of asbestos as a part of their
contractual obligations.
NAICO also insures independent oil and gas producers who may purchase
coverage for the escape of oil, saltwater, or other substances which may be
harmful to persons or property, but may not generally be classified as
pollutants. Chandler Barbados reinsures a portion of those risks. The
Company
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 the Company, 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 financial
condition of the Company.
REGULATION
The Company's insurance subsidiaries are subject to regulation by
government agencies in the jurisdictions in which they do 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, 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 security holders.
In addition to the regulatory oversight of the Company's insurance
subsidiaries, the Company is also subject to regulation under the laws of the
Cayman Islands and the Nebraska Insurance Holding Company System Act (the
"Holding Company Act"). The Holding Company Act contains certain reporting
requirements including those requiring the Company, 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.
Persons owning any securities of the Company must comply with the Holding
Company Act (see "BUSINESS - Regulation").
Insurance companies are also affected by a variety of state and federal
legislative and regulatory measures and judicial decisions that define and
extend the risks and benefits for which insurance is sought and provided.
These include 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.
ECONOMIC CONDITIONS
The impact on the Company of a recession 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 $89.7
million,
or 73% of NAICO's direct written premiums in 1997 were in the states of
Oklahoma and Texas. An economic downturn in these regions could have a
significant impact on the Company. A recession might also cause defaults on
fixed-income securities. Management believes it has mitigated the impact of a
recession by employing conservative underwriting practices and strict credit
policies and maintaining a high-quality investment portfolio.
<PAGE>
PAGE
23
Periods of inflation have varying effects on the Company's subsidiaries
as
well as other companies in the insurance industry. Inflation contributes to
higher claims and related costs and operating costs as well as higher interest
rates which generally provide for potentially higher interest rates on
investable cash flow and decreases in the market value of existing
fixed-income
securities. Premium rates and commissions, however, are not significantly
affected by inflation since competitive forces generally control such rates.
NAICO's underwriting philosophy is to forego underwriting risks from
which
it is unable to obtain what it believes to be adequate premium rates. The
effect of inflation on the operations of the Company was not significant
during
the period from 1995 through 1997.
READINESS FOR YEAR 2000
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
problems
("Year 2000 Problems") errors could result. These errors could cause damage
to
personal property and disrupt business practices and functions.
The Company has taken action to understand the nature and extent of the
work required to make its systems, products and infrastructures Year 2000
compliant. NAICO 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 substantially complete at this time. NAICO
continues to evaluate the estimated costs associated with future efforts based
on actual experience. While these efforts may involve additional costs, the
Company believes, based on available information, that it will be able to
manage any significant effect on its business operations, products or
financial
prospects without incurring significant additional costs.
The Company continues to study the complex issues related to insurance
coverage for losses arising from the myriad potential fact situations
connected
with Year 2000 Problems. The Company believes that the coverages it provides
do not extend to the types of losses which are most likely to occur as a
result
of Year 2000 Problems. The Company has made no provisions for reserves nor
has
it undertaken any modifications of its policy forms based on potential Year
2000 Problems. The Company may utilize coverage exclusion endorsements based
on the individual underwriting of commercial accounts.
It is possible, however, that future court interpretation of policy
language based on specific facts could result in coverage for losses
attributable to Year 2000 Problems. Such decisions could have a material
adverse impact on the Company. It is also possible that the Company may incur
expenses defending claims for which it is ultimately determined there is no
insurance coverage.
Likewise, the Company cannot predict the adverse impact, if any, of Year
2000 Problems upon its agents, customers, reinsurers and others who are or may
be indebted to the Company. It is possible that the credit or ability of
others with whom the Company maintains commercial relationships may be
adversely affected by one or more unforeseen circumstances caused by Year 2000
Problems.
ANALYSIS OF INSURANCE PROGRAM RESULTS OF OPERATIONS
The following tables summarize the net premiums earned and the financial
year (losses incurred and recognized by the Company regardless of the year in
which the claim occurred) and accident year (losses incurred by the Company
for
a particular year regardless of the period in which the Company recognizes the
costs) loss and loss adjustment expense ("LAE") 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:
<PAGE>
PAGE
24
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- ------------------------------------
INSURANCE PROGRAM 1995 1996 1997
- ----------------------------------------- ---------- ----------
- ----------
(Dollars in thousands)
<S> <C> <C> <C>
STANDARD PROPERTY-CASUALTY
Net premiums earned.................... $ 29,588 $ 38,330 $ 55,527
Financial year loss & LAE ratio........ 60.1 % 59.0 % 67.1
%
Accident year loss & LAE ratio......... 59.3 % 60.8 % 63.3
%
POLITICAL SUBDIVISIONS
Net premiums earned.................... $ 12,472 $ 14,017 $ 14,945
Financial year loss & LAE ratio........ 61.1 % 57.6 % 56.8
%
Accident year loss & LAE ratio......... 57.4 % 62.4 % 60.6
%
SURETY BONDS
Net premiums earned.................... $ 14,162 $ 10,020 $ 11,117
Financial year loss & LAE ratio........ 56.1 % (0.7)% 8.6
%
Accident year loss & LAE ratio......... 46.1 % 37.0 % 11.3
%
NONSTANDARD PRIVATE-PASSENGER AUTOMOBILE
Net premiums earned.................... $ 15,234 $ 16,595 $ 8,841
Financial year loss & LAE ratio........ 83.2 % 86.2 % 72.2
%
Accident year loss & LAE ratio......... 88.3 % 83.6 % 65.9
%
TRANSPORTATION
Net premiums earned.................... $ 3,098 $ 1,152 $
(171)
Financial year loss & LAE ratio........ (2.3)% 338.4 %
(925.2)%
Accident year loss & LAE ratio......... 99.1 % 76.2 %
(194.6)%
OTHER
Net premiums earned.................... $ 6,533 $ 9,172 $ 4,420
Financial year loss & LAE ratio........ 58.8 % 49.6 % 64.5
%
Accident year loss & LAE ratio......... 73.8 % 48.6 % 47.7
%
TOTAL
Net premiums earned.................... $ 81,087 $ 89,286 $ 94,679
Financial year loss & LAE ratio........ 62.3 % 59.8 % 60.7
%
Accident year loss & LAE ratio......... 64.8 % 61.8 % 56.7
%
LINE OF INSURANCE
- -----------------------------------------
WORKERS COMPENSATION
Net premiums earned.................... $ 37,066 $ 42,813 $ 44,954
Financial year loss & LAE ratio........ 62.2 % 53.1 % 66.3
%
Accident year loss & LAE ratio......... 57.8 % 56.4 % 67.6
%
AUTOMOBILE LIABILITY
Net premiums earned.................... $ 15,498 $ 17,581 $ 15,593
Financial year loss & LAE ratio........ 74.3 % 97.6 %
89.1%
Accident year loss & LAE ratio......... 99.0 % 76.8 %
69.6%
OTHER LIABILITY
Net premiums earned.................... $ 6,579 $ 8,656 $ 12,209
Financial year loss & LAE ratio........ 42.9 % 59.9 % 48.5
%
Accident year loss & LAE ratio......... 54.2 % 51.8 % 41.4
%
SURETY AND FIDELITY BONDS
Net premiums earned.................... $ 14,237 $ 10,123 $ 11,256
Financial year loss & LAE ratio........ 56.1 % (0.6)% 8.7
%
Accident year loss & LAE ratio......... 45.8 % 36.8 % 11.4
%
AUTOMOBILE PHYSICAL DAMAGE
Net premiums earned.................... $ 5,881 $ 6,788 $ 5,726
Financial year loss & LAE ratio........ 68.3 % 73.6 % 59.8
%
Accident year loss & LAE ratio......... 72.0 % 77.2 % 59.0
%
ACCIDENT & HEALTH
Net premiums earned.................... $ 230 $ 564 $ 2,529
Financial year loss & LAE ratio........ (48.5)% 56.1 % 43.1
%
Accident year loss & LAE ratio......... 46.1 % 105.2 % 33.4
%
PROPERTY
Net premiums earned.................... $ 1,369 $ 1,467 $ 1,912
Financial year loss & LAE ratio........ 73.1 % 113.8 % 74.1
%
Accident year loss & LAE ratio......... 84.3 % 109.5 % 67.6
%
INLAND MARINE
Net premiums earned.................... $ 227 $ 1,294 $ 500
Financial year loss & LAE ratio........ 84.1 % 114.7 % 194.6
%
Accident year loss & LAE ratio......... 102.1 % 145.5 % 119.0
%
TOTAL
Net premiums earned.................... $ 81,087 $ 89,286 $ 94,679
Financial year loss & LAE ratio........ 62.3 % 59.8 % 60.7
%
Accident year loss & LAE ratio......... 64.8 % 61.8 % 56.7
%
</TABLE>
<PAGE>
PAGE
25
NET INCOME (LOSS)
A net loss of $1,065,000 resulted in 1997 compared to net income of
$972,000 in 1996 and $3,778,000 in 1995. In 1997, the Company recorded a net
charge totaling approximately $1.4 million ($1.6 million including provision
for federal income tax) for the litigation matters related to the legal
proceedings involving the CenTra Group. The ultimate actual amounts allowed
by
the Court to all parties could vary significantly from the Company's estimate.
The net charge has been reduced by an estimated recovery of $2.7 million from
the Company's directors and officers policy insurer for costs associated with
the defense and litigation of these matters. See "LEGAL PROCEEDINGS". In
addition, significant litigation expenses were incurred in 1997 due to the
trial which began on February 13, 1997. The Company has also resolved various
issues resulting in settlement of litigation and arbitration proceedings among
subsidiaries of the Company and CenTra affiliates and recorded litigation and
settlement expenses of approximately $462,000 in 1997. Excluding the effects
of the litigation expenses and the estimated recovery, net income would have
been approximately $3.4 million in 1997.
Earnings for 1996 were affected by charges totaling $1.5 million for the
settlement attributed to legal proceedings and related matters arising from
the
termination of an underwriting and production contract with the Company's
former underwriting manager for a portion of the Company's surety bond
program.
In addition, legal expenses related to this matter were $441,000 for 1996.
The
Company's results for 1996 also reflect a charge totaling $1.1 million from an
arbitration award that was lower than expected. Legal expenses related to the
arbitration award were $527,000 in 1996.
In 1996, the Company recorded a $982,000 estimated recovery of costs from
its directors and officers liability insurer related to the Company's claim
for
reimbursable amounts previously paid for defense and litigation costs
associated with the litigation involving the CenTra Group. Excluding the
effects of the unusual charges and related expenses and the estimated
recovery,
net income would have been approximately $2.7 million for 1996. In 1995, the
Company recorded an estimated recovery of $818,000 from the Company's
directors
and officers liability insurer.
NET PREMIUMS EARNED
Net premiums earned increased 1%, 10% and 6% in 1995, 1996 and 1997,
respectively, compared to the prior years.
In 1995, NAICO elected to commute the unpaid losses and loss adjustment
expenses related to reinsurance contracts covering certain business written in
1993, 1994 and 1995 which resulted in an increase in net premiums earned of
$2,285,000. Beginning in 1996, NAICO reviewed the historical results for
reinsurance contracts with similar commutation provisions and began accruing
for such commutations where a commutation election was considered likely.
Excluding the effects of these commutation accruals and elections, net
premiums
earned decreased 2% in 1995, and increased 12% and 5% in 1996 and 1997,
respectively. The effect of the commutation accruals and elections was to
increase net premiums earned for each insurance program as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- ------------------------------
1995 1996 1997
-------- --------
- --------
(Dollars in thousands)
<S> <C> <C> <C>
Standard property-casualty........................$ 1,223 $ 383 $
946
Political subdivisions............................ 593 320
662
Other programs combined........................... 469 27
40
-------- --------
- --------
$ 2,285 $ 730 $
1,648
======== ========
========
</TABLE>
During 1993, NAICO expanded the standard property-casualty program by
offering automobile liability and physical damage, general and umbrella
liability and property coverages in addition to workers compensation and
increased its marketing activity in Oklahoma and contiguous states,
principally
Texas. Excluding the effects of the commutations described above, net
premiums
earned for the standard property-casualty program increased 28%, 34% and 44%
in
1995, 1996 and 1997, respectively, generally due to the product and territory
expansion described above.
Net premiums earned in the surety bond program decreased 29% in both 1995
and 1996 and increased 11% in 1997 compared to the prior years. NAICO and
Midwest Indemnity Corporation ("Midwest"), the underwriting manager for a
large
portion of the surety bond program agreed to terminate the underwriting and
production contract effective December 31, 1995. Midwest produced $1.0
million
and $251,000 in gross written and assumed premiums in 1996 and 1997,
respectively, during the runoff of that portion of the program. Midwest
produced $8.2 million in gross written and assumed premiums in 1995. Direct
surety premiums written for NAICO by L&W personnel were $4.8 million in 1995,
$8.0 million in 1996 and $9.6 million in 1997. The increase is primarily a
result of expansion in New Mexico and California.
Excluding the effects of the commutations described above, net premiums
earned for the political subdivisions program increased 10%, 15% and 4% in
1995, 1996 and 1997, respectively, from the prior years. Net premiums earned
for the municipalities portion of this program increased 44%, 81% and 4% in
1995, 1996 and 1997, respectively. NAICO expanded its book of business
through
local agents in Oklahoma and expanded its coverage for municipalities to
include workers compensation in 1995. NAICO also began insuring counties in
1995. Net premiums earned for the school districts portion of the program
increased 3% in 1995, decreased 1% in 1996 and increased 4% in 1997.
Expansion
of the school districts program in Texas accounted for most of the 1997
increase.
<PAGE>
PAGE
26
NAICO participates in various mandatory pools covering workers
compensation for insureds that were unable to purchase this coverage from an
insurance company on a voluntary basis. In addition, NAICO receives
assignments to write workers compensation for such insureds in certain states
in lieu of participation in related pools. Net premiums earned from these
direct assignments and participation in related pools were $6.8 million in
both
1995 and 1996 and $1.3 million in 1997. The decline in 1997 was attributable
to decreased activity from the pools and fewer assignments in certain states.
Both the size of the involuntary market and NAICO's relative participation in
states having a mandatory pool mechanism declined in 1996 and 1997.
During late 1993, NAICO began writing nonstandard private-passenger
automobile liability and automobile physical damage in Oklahoma. During mid-
1994, NAICO began writing these coverages in California and Arizona. Net
premiums earned in each state were as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- ------------------------------
1995 1996 1997
-------- --------
- --------
(Dollars in thousands)
<S> <C> <C> <C>
Oklahoma..........................................$ 4,438 $ 4,326 $
1,485
Arizona........................................... 4,085 2,625
962
California........................................ 6,711 9,644
6,394
-------- --------
- --------
$ 15,234 $ 16,595 $
8,841
======== ========
========
</TABLE>
The 1997 decreases in Oklahoma and Arizona were generally a result of
premium rate increases, reductions in the number of retail agents offering
these programs and the discontinuance of these programs during 1997.
During the second quarter of 1997, management reviewed the underwriting
performance of the California portion of the program and concluded that it
would be in the Company's best interest to substantially reduce its
underwriting risk. Effective July 1, 1997, NAICO entered into a 100% quota
share reinsurance agreement with Underwriters Reinsurance Company to fully
reinsure the risk. In December 1997, the reinsurance contract was amended and
Jefferson Insurance Company of New York replaced Underwriters Reinsurance
Company.
NAICO's largest underwriting manager was responsible for underwriting
$11.5 million, $11.9 million and $12.3 million of NAICO's direct written and
assumed premiums for the California and Arizona portions of the nonstandard
private-passenger automobile program during 1995, 1996 and 1997, respectively.
Premiums receivable and currently due from this underwriting manager were
$596,000 and $612,000 at December 31, 1996 and 1997, respectively.
In the second quarter of 1996, NAICO began writing excess accident and
health coverage for small and medium sized employers generally in Oklahoma and
Texas. Net premiums earned in this program were $316,000 and $2.3 million in
1996 and 1997, respectively.
During the first quarter of 1994, management reviewed the underwriting
performance of the transportation programs and concluded that it would be in
the Company's best interest to discontinue writing transportation automobile
liability business based on the underwriting results and other related
factors.
As a result, net premiums earned declined substantially from that point. The
Company continues to service the transportation industry in its retail and
risk
brokerage operations and all risk management services provided by NAICO are
available.
INVESTMENT INCOME
Net investment income decreased in 1996 compared to 1995 primarily as a
result of a reduction in invested assets and a decrease in net realized
capital
gains. Invested assets declined primarily as a result of the payment of loss
and loss adjustment expense reserves corresponding to the planned reduction of
certain insurance programs within the Company's book of insurance business
during 1991 through 1994. Net investment income increased 9% in 1997 compared
to the prior year primarily as a result of an increase in net realized capital
gains.
Net realized capital gains were $412,000, $140,000 and $764,000 in 1995,
1996 and 1997, respectively. The average net yield on the portfolio,
including
net realized capital gains, was 6.5% in 1995, 6.1% in 1996 and 6.6% in 1997.
The 1997 net realized capital gains resulted primarily from NAICO shifting a
portion of its fixed maturities portfolio from taxable to tax exempt bonds and
NAICO's sale of Century Business Services, Inc. common stock. The Century
Business Services stock was received in early 1997 as a part of a 1996
settlement with a former underwriting manager. The average net yield
excluding
net realized capital gains for these years was 6.1%, 6.0% and 5.9%,
respectively.
COMMISSIONS, FEES AND OTHER INCOME
L&W's brokerage commissions and fees before intercompany eliminations
were
$8.2 million in 1995, $8.5 million in 1996 and $9.0 million in 1997. A large
portion of the brokerage commission and fees for L&W is incurred by NAICO and
thus eliminated in the consolidation of the Company's subsidiaries.
Commissions and fees generated by Network were $148,000 in 1995, $722,000
in 1996 and $435,000 in 1997. Network is a third-party administrator of
partially self-insured group accident and health plans. The Company acquired
Network in the fourth quarter of 1995. Network's operations were consolidated
into a joint venture in the third quarter of 1997. Effective December 31,
1997, Network's participation in the joint venture was terminated and Network
no longer functions as a third-party administrator.
<PAGE>
PAGE
27
LOSSES AND LOSS ADJUSTMENT EXPENSES
The Company 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 independent professional actuaries periodically review such
estimates.
The percentage of losses and loss adjustment expenses to net premiums
earned was 62.3%, 59.8% and 60.7% in 1995, 1996 and 1997, respectively. In
1996, the Company decreased the estimated ultimate loss ratio of a substantial
portion of the surety bond program, which decreased the loss ratio by 3.1
percentage points. This decrease was offset by corresponding adjustments to
policy acquisition costs. In addition, the loss commutations discussed
previously decreased the 1995, 1996 and 1997 loss ratios by 1.8, 0.5 and 1.1
percentage points, respectively.
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 certain of 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.
The following table sets forth the Company's policy acquisition costs for
each of the three years ended December 31, 1995, 1996 and 1997:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- ------------------------------------
1995 1996 1997
---------- ----------
- ----------
(Dollars in thousands)
<S> <C> <C> <C>
Commissions expense.........................$ 11,506 $ 16,489 $
15,860
Other premium related assessments........... 1,704 1,258
744
Premium taxes............................... 2,486 2,705
3,400
Excise taxes................................ 138 109
153
Dividends to policyholders.................. 434 454
1,155
Other expense............................... 168 365
146
---------- ----------
- ----------
Total direct expenses....................... 16,436 21,380
21,458
Indirect underwriting expenses.............. 10,515 14,831
13,464
Commissions received from reinsurers........ (3,162) (2,895)
(6,458)
Adjustment for deferred acquisition costs... 206 (1,193)
(319)
---------- ----------
- ----------
Net policy acquisition costs................$ 23,995 $ 32,123 $
28,145
========== ==========
==========
</TABLE>
Total gross direct and indirect expenses as a percentage of direct
written
and assumed premiums were 27.3%, 33.5% and 28.4% in 1995, 1996 and 1997,
respectively. For these periods, the average commission rates were 11.6%,
15.3% and 12.9%. The commission rate for a substantial portion of the surety
bond program varies inversely with the loss ratio pursuant to a commission
arrangement contingent on the loss experience of the program. The expected
loss
ratio for that portion of the surety bond program was lowered in 1996 and that
decrease increased the percentage of net policy acquisition costs to net
premiums earned by 3.1 percentage points.
Indirect expenses were 10.6%, 13.7% and 10.9% of total direct written and
assumed premiums in 1995, 1996 and 1997, 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 the Company's overall premium volume. The
Company incurred $1,534,000 in indirect underwriting expenses related to the
Midwest termination settlement, which was 1.4% of direct written and assumed
premiums in 1996. Commissions received from reinsurers increased in 1997 as a
result of the 100% quota share reinsurance arrangement for the California
portion of the nonstandard private-passenger automobile program which was
effective July 1, 1997. NAICO ceded premiums of $7,473,000 and received
commissions totaling $1,868,000 under this quota-share reinsurance
arrangement.
The Company incurred $440,000, $2,078,000 and $527,000 in indirect
underwriting expenses for uncollectible ceded reinsurance in 1995, 1996 and
1997, respectively, which was 0.4%, 1.9% and 0.4% of direct written and
assumed
premiums in those periods. The 1996 amount includes an arbitration award
which
was made against New York Life Insurance Company, Security Benefit Life
Insurance Company and Standard Insurance Company and in favor of NAICO but for
$1.1 million less than had been expected. NAICO reduced its reinsurance
recoverables accordingly. See Notes to Consolidated Financial Statements.
<PAGE>
PAGE
28
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were 15.2%, 15.3% and 14.0% of
revenues exclusive of net investment income in 1995, 1996 and 1997,
respectively. General and administrative expenses have historically not
varied
in direct proportion to the Company'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 the Company's overall premium volume. In 1996, the
Company incurred $441,000 in legal expenses related to the Midwest termination
settlement, and $527,000 in legal expenses related to the reinsurance
arbitration discussed above.
LIQUIDITY AND CAPITAL RESOURCES
The Company is a holding company receiving cash principally through
equity
sales, borrowings and subsidiary dividends, subject to various regulatory
restrictions described in "Regulation" and Notes to Consolidated Financial
Statements. The capacity of insurance and reinsurance companies to underwrite
insurance and reinsurance is based on maintaining liquidity and capital
resources sufficient to pay claims and expenses as they become due. The
primary sources of liquidity for the Company's subsidiaries are funds
generated
from insurance and reinsurance premiums, investment income, capital
contributions from the Company 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.
All significant Company subsidiaries maintain liquid operating positions
and follow 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 and assume reinsurance.
Fixed-maturity investments are purchased to support the investment
strategies of the Company 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 the Company 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. The Company 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 tax as a separate component of shareholders' equity until
realized.
In 1997, NAICO provided $5.1 million in cash from operations and Chandler
Barbados used $2.9 million cash in operations. To augment maturities and
reposition their portfolios, Chandler Barbados and NAICO chose to liquidate
certain fixed maturity securities that were available for sale prior to their
maturities.
In addition, NAICO sold the common stock of Century Business Services,
Inc. (formerly International Alliance Services, Inc.) for a total of
$2,459,000. The Century Business Services common stock was received as a part
of its 1996 settlement with Midwest. The Company realized net capital gains
before income taxes in 1997 in the amount of $764,000 from the sale of
investments. In 1997, Chandler Barbados and NAICO received proceeds of $3.5
million and $18.7 million, respectively, from the sale of fixed-income
securities that were available for sale prior to their maturity. The average
maturity of the Company's investments was 4.81 years and 4.59 years at
December
31, 1996 and 1997, respectively.
During 1996, Chandler USA borrowed $4.5 million from a bank on a three
year note payable. The note had a floating interest rate at Wall Street
Journal Prime and principal and interest are payable monthly. Proceeds from
the note were used to repay intercompany advances from Chandler Barbados.
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 Wall
Street Journal Prime, which was 8.5% at December 31, 1997. The note is
collateralized by the shares of NAICO stock owned by Chandler USA and includes
certain loan covenants. The outstanding balance of the note was $2,646,000 at
December 31, 1997.
All or a portion of the available borrowing capacity under the note may
be
used to post needed bonds or to discharge judgments entered in the CenTra
litigation. The Company is considering a number of options to deal with these
issues and believes it has made appropriate provision based upon known facts.
Chandler Barbados is required as a foreign reinsurer to secure reserves
for unpaid losses and loss adjustment expenses and unearned premiums for the
benefit of the primary insurer ceding such amounts. Chandler Barbados secures
such amounts by trust arrangements whereby securities are deposited into a
trust account for the benefit of the primary insurer. 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. NAICO also has
deposited funds pursuant to a trust arrangement securing reinsurance
obligations it has assumed from an unrelated primary carrier. At December 31,
1997, the total amount of cash and investments restricted for Chandler
Barbados
and NAICO as a result of these arrangements was $16.7 million and $8.5
million,
respectively.
<PAGE>
PAGE
29
CENTRA LITIGATION
In 1992, the Company became involved in certain legal proceedings beyond
the ordinary course of business. These proceedings generally involve CenTra.
The Company has incurred approximately $2.5 million, $2.1 million, $1.9
million, $1.1 million, $857,000 and $7.5 million in costs attributable to
these
legal proceedings during 1992, 1993, 1994, 1995, 1996 and 1997, respectively,
before recoveries from the Company's directors and officers policy insurer.
The amount for 1997 includes approximately $1.4 million for the Oklahoma
Federal Court judgments, $2.9 million for litigation expenses and $462,000
related to the settlement of certain litigation and arbitration proceedings.
As a result of various events in 1995, the Company recorded an $818,000
estimated recovery of costs from its directors and officers policy 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,
the Company recorded an additional estimated recovery of $982,000. The
Company
received a payment for the 1995 claim during 1996 in the amount of $795,000.
In connection with the Oklahoma Federal Court judgments, the Company recorded
an additional estimated recovery of $2.7 million from the Company's directors
and officers policy insurer. The Company is entitled to a total of $5 million
under the applicable insurance policy. Some amounts have been previously paid
without dispute and the Company is negotiating with the insurer for payment of
the policy balance. The Company could recover the remaining policy limits or
could compromise its claim, and could incur significant costs in either case.
The estimated insurance recovery is based upon these variable factors.
See "Liquidity and Capital Resources", "LEGAL PROCEEDINGS" and Notes to
Consolidated Financial Statements.
NAICO and NAICO Indemnity provided insurance coverage and risk management
services for CenTra and certain of its affiliates. 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. The Company intends to seek payment of all amounts due and believes
a reserve for collection is not necessary at December 31, 1997. In addition,
the Company's subsidiaries reflected a payable to certain affiliates of CenTra
in the amount of $505,000 at December 31, 1997 in connection with the
settlement of certain litigation and arbitration proceedings. See "LEGAL
PROCEEDINGS".
The Company's management believes that adequate financial resources are
available to post a supersedeas bond if the judgments are appealed, and the
Company is pursuing various financing arrangements in the event that the
judgments are not reduced or overturned. As a holding company, the Company
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. See "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -
Liquidity and Capital Resources". A reduction in the amount of invested
assets, or an increase in borrowings resulting from potential payment of these
judgments would reduce investment earnings or increase operating expenses in
future periods.
CERTAIN TAX MATTERS
During 1996, the IRS conducted a field examination of the U.S. Federal
income tax returns of Chandler USA and its wholly owned subsidiaries for the
years 1993 and 1994. The IRS completed the examination in the fourth quarter
of 1996, and there were no proposed adjustments to tax liabilities.
ACCOUNTING STANDARDS ISSUED BUT NOT YET ADOPTED
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, REPORTING
COMPREHENSIVE INCOME, which establishes standards for reporting and displaying
comprehensive income and its components (revenues, expenses, gains and losses)
in financial statements. In addition, SFAS No. 130 requires the Company to
classify items of other comprehensive income by their nature in a financial
statement and display the accumulated balance of other comprehensive income
separately in the shareholders' equity section of the consolidated balance
sheets. The Company will adopt SFAS No. 130 on January 1, 1998 as required.
Also in June 1997, the FASB issued SFAS No. 131, DISCLOSURES ABOUT
SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION. SFAS No. 131 establishes
reporting standards for public companies concerning annual and interim
financial statements of their operating segments and related information.
Operating segments are components of a company about which separate financial
information is available that is regularly evaluated by the chief operating
decision maker(s) in deciding how to allocate resources and assess
performance.
The Standard sets criteria for reporting disclosures about a company's
products
and services, geographic areas and major customers. The Company will adopt
SFAS No. 131 on January 1, 1998 as required.
FORWARD-LOOKING STATEMENTS
Some of the statements made in this Form 10-K report, as well as
statements made by the Company in periodic press releases, oral statements
made
by the Company's officials to analysts and shareholders in the course of
presentations about the Company 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 the Company
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 the
Company
operates; (iv) claims frequency; (v) claims severity; (vi) the number of new
and renewal policy applications submitted by the Company's agents; and (vii)
other factors such as the ongoing litigation matters involving a significant
concentration of ownership of common stock.
<PAGE>
PAGE
30
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Item 14.
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
DIRECTORS AND EXECUTIVE OFFICERS
A brief description of each director and executive officer of the Company
is provided below. Directors hold office until the next annual meeting of
shareholders or until their respective successors are duly elected and
qualified. Executive officers are elected by the Board of Directors at its
annual meeting and hold office until its next annual meeting or until their
respective successors are duly elected and qualified. The current directors
and executive officers of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- --------------------------- --- --------------------------------------------
<S> <C> <C>
W. Brent LaGere............ 52 Chairman of the Board, Chief Executive
Officer, President, Executive Committee
Chairman, Investment Committee Member and
Director.
Brenda B. Watson........... 57 Executive Vice President, Executive
Committee Member and Director.
Richard L. Evans........... 51 Vice President and Director.
Mark T. Paden.............. 41 Vice President - Finance, Chief Financial
Officer, Treasurer, Investment Committee
Member and Director.
Steven R. Butler........... 40 Vice President - Administration.
Norman E. Harned........... 57 Director.
James M. Jacoby............ 63 Audit Committee Member, Option and
Compensation Committee Chairman and
Director.
Ronald W. Lech............. 68 Director.
Paul A. Maestri............ 67 Audit Committee Member, Option and
Compensation Committee Member and
Director.
M. J. Moroun............... 70 Investment Committee Member, Executive
Committee Member and Director.
Robert L. Rice............. 63 Audit Committee Chairman, Executive
Committee Member, Option and Compensation
Committee Member and Director.
Larry A. Davis............. 56 Director.
</TABLE>
W. BRENT LAGERE has been Chairman of the Board of the Company since
September 1983, Chief Executive Officer since March 1986 and President since
May 1997. Since October 1988 he has served in officer and director capacities
for various subsidiaries of the Company pursuant to an employment contract
with
Chandler USA. Since 1971 he has served in various capacities with L&W.
<PAGE>
PAGE
31
BRENDA B. WATSON has been Executive Vice President of the Company since
October 1988, was a Vice President of the Company for three years prior
thereto, and has been a director of the Company since September 1985. Since
October 1988 she has served in officer and director capacities for various
subsidiaries of the Company pursuant to an employment contract with Chandler
USA.
RICHARD L. EVANS has been a director of the Company since September 1983.
He has been a Vice President of the Company since August 1986, and since May
1989, he has been an employee of Chandler USA. Mr. Evans has served L&W since
1979 in various capacities. Mr. Evans has also been a director of Chandler
USA
since May 1990.
MARK T. PADEN has served as Vice President-Finance of the Company since
August 1987 and director since May 1992. Since February 1987 Mr. Paden has
been an employee of L&W and/or Chandler USA. Mr. Paden has served as the Vice
President-Finance and Chief Financial Officer of NAICO since January 1988 and
Vice President-Finance and Chief Financial Officer of L&W since May 1987. Mr.
Paden has also been a director of Chandler USA since July 1988, NAICO since
November 1992 and L&W since October 1992.
STEVEN R. BUTLER has served as Vice President-Administration of the
Company since January 1987, and also serves as a director, the President and
Treasurer of CIM Barbados. He is also a director and the Financial Director
of
CIM. The Company began handling its own and Chandler Barbados' operations and
administrative affairs through CIM and CIM Barbados, respectively, in 1990.
From 1984 through 1989, Mr. Butler served as Financial Director of Insurance
Management Services, Ltd. and, beginning in 1988, of its affiliate Insurance
Risk Management Services, Ltd., which performed substantially all of the
administrative management functions of the Company and Chandler Barbados,
respectively, through March 1990.
NORMAN E. HARNED has been a director of the Company since 1989. Mr.
Harned has served as Vice President of CenTra for more than five years.
JAMES M. JACOBY has been a director since October 1993. He has been a
director of NAICO since August 1990. He has been an insurance agent for more
than five years and was formerly employed by NAICO from June 1990 to March
1991. Mr. Jacoby retired in September 1994 from Alexander and Alexander, Inc.
and is currently employed by Constructor's Bonding & Insurance in Omaha,
Nebraska.
RONALD W. LECH has been a director since June 1992. Until June 2, 1995,
Mr. Lech had been an Executive Vice President of CenTra for more than five
years, but is currently retired.
PAUL A. MAESTRI has been a director of the Company since October 1985.
Since February 1990 Mr. Maestri has engaged in personal investment activities.
From 1980 to February 1990 Mr. Maestri was a director and the President and
Chief Executive Officer of P.A.M. Transport, Inc. He has also been a director
of L&W since December 1993 and of NAICO since May 1997.
M. J. MOROUN has been a director of the Company since 1989. Mr. Moroun
has been Chief Executive Officer of CenTra for more than five years.
ROBERT L. RICE has been in private practice as a certified public
accountant for more than five years and a director of the Company since May
1987. Mr. Rice has also been a director of Chandler USA since June 1993 and
of
L&W since May 1997.
LARRY A. DAVIS has been a director of the Company since August 1997. Mr.
Davis has also been a director of Chandler Barbados and CIM Barbados since
December 1992. Currently Mr. Davis is employed by Loewen Financial
Corporation, a Barbados corporation.
COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934
Based solely upon a review of Forms 3, 4 and 5, any amendments thereto
furnished to the Company pursuant to the rules of the Securities and Exchange
Commission, or written representations from certain reporting persons
presented
to the Company, all such reports required to be filed by reporting persons
have
been filed in a timely fashion during the fiscal year ended December 31, 1997.
<PAGE>
PAGE
32
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth the compensation paid or to be paid by the
Company or any of its subsidiaries as well as certain other compensation paid
or accrued, during the years indicated, to the Chairman and Chief Executive
Officer and the four other highest paid executive officers of the Company (the
"named executives") for such period in all capacities in which they served.
<TABLE>
<CAPTION>
SUMMARY COMPENSATION
TABLE
LONG TERM COMPENSATION
-------------------------------
ANNUAL COMPENSATION
(1) AWARDS PAYOUTS
- ----------------------------- --------------------- -------
OTHER RESTRICTED
ANNUAL STOCK OPTIONS/ LTIP ALL OTHER
SALARY BONUS
COMPENSA- AWARD(S) SARS PAYOUTS COMPENSA-
NAME AND PRINCIPAL POSITION YEAR ($) ($)
TION($)(2) ($) (#) ($) TION ($)(4)
- ---------------------------------------- ---- -------- -----
- ---------- ---------- -------- ------- -----------
<S> <C> <C> <C>
<C> <C> <C> <C> <C>
W. Brent LaGere 1997 $389,340 $ -
N/A - - - $ 37,471
Chairman of the Board, CEO and 1996 378,610 -
N/A - - - 40,148
President of Chandler USA, NAICO 1995 373,369 -
N/A - - - 28,113
and L&W
Benjamin T. Walkingstick (3) 1997 334,123 -
N/A - - - 15,625
Former President of Chandler USA, 1996 314,321 -
N/A - - - 41,052
NAICO and L&W; and former 1995 312,294 -
N/A - - - 29,400
Treasurer of L&W
Brenda B. Watson 1997 216,882 -
N/A - - - 8,475
Executive Vice President of 1996 211,182 -
N/A - - - 15,552
NAICO and L&W 1995 206,154 -
N/A - - - 4,500
Richard L. Evans 1997 211,873 -
N/A - - - 6,275
Vice President-Claims of 1996 205,896 -
N/A - - - 13,752
Chandler USA, NAICO and L&W 1995 199,939 -
N/A - - - 3,000
Mark T. Paden 1997 178,637 -
N/A - - - 4,975
Vice President-Finance & CFO of 1996 173,188 -
N/A - - - 12,752
Chandler USA, NAICO and L&W 1995 168,218 -
N/A - - - 2,000
Steven R. Butler 1997 127,514 12,850
N/A - - - -
President of CIM and CIM Barbados 1996 122,610 14,554
N/A - - - -
1995 117,757 14,710
N/A - - - -
- ----------------------------------------
<FN>
(1) Amounts shown include cash and non-cash compensation earned and received
by the named executives as well as amounts earned but deferred at their
election.
(2) The Company provides various perquisites to certain employees including
the named executives. In each case, the value of the perquisites
provided
to the named executives did not exceed ten percent of such named
executives' annual salary and bonus.
(3) Mr. Walkingstick resigned his positions as President of Chandler USA,
NAICO and L&W effective May 1, 1997. The 1997 amounts above include Mr.
Walkingstick's compensation subsequent to his resignation pursuant to an
Employment Agreement. See "Employment Agreements".
(4) The amounts shown under this column represent contributions by the
Company's U.S. subsidiaries to a 401(k) plan ($1,000 for each of the
named
executives in 1995, $11,552 in 1996 and $3,475 in 1997 (except for Mr.
Walkingstick whose 1997 contribution was $1,625)) and the premiums paid
or
to be paid by the Company's U.S. subsidiaries under life insurance
arrangements with the named executives. A portion of the premiums
($32,100, $34,500 and $24,300 in 1995, 1996 and 1997, respectively) were
paid under split dollar life insurance plans. Under these plans, the
Company's U.S. subsidiaries pay the premiums for life insurance issued to
the named executive. Repayment of the premiums is secured by the death
benefit or the cash surrender value of the policy, if any, if the
executive cancels and surrenders the policy.
</TABLE>
OPTIONS EXERCISED AND HOLDINGS
No options were exercised during 1997 and there were no unexercised
options held as of December 31, 1997.
DIRECTOR COMPENSATION
Messrs. Harned, Lech, Maestri, Moroun, Jacoby, Davis and Rice -- the
Company's outside directors -- receive an annual retainer of $6,000 and $1,000
for each meeting. These outside directors are compensated at the rate of
$1,000 per day for time spent on board-related activities. Due primarily to
time spent in connection with certain litigation, Messrs. Maestri, Rice and
Jacoby received total director compensation during 1997 of $82,750, $75,250
and
$43,500, respectively. See "LEGAL PROCEEDINGS - CenTra Litigation".
<PAGE>
PAGE
33
EMPLOYMENT AGREEMENTS
Chandler USA has employment agreements with Mr. LaGere and Ms. Watson.
The
agreements contain self-renewing terms of five years limited to the employee
attaining age 70. The salary amounts reflected in the foregoing table
represent amounts paid as required by the contracts for the years indicated.
Under certain limited circumstances, such officers could receive base salaries
subsequent to an early termination of their employment subject to certain
continued obligations to Chandler USA.
Prior to May 1, 1997, Benjamin T. Walkingstick was an employee of
Chandler
USA pursuant to an employment agreement dated October 28, 1988, (the
"Employment Agreement") and served as an executive officer and director of the
Company and certain of its subsidiaries. Effective May 1, 1997, Mr.
Walkingstick resigned these positions and ceased to be an employee of Chandler
USA. He continues to be a consultant to Chandler USA and its subsidiaries
pursuant to the Employment Agreement and continues to receive compensation at
an annual rate of $323,291 under the Employment Agreement through October 2000
at which time he reaches age 70. See "CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS".
Chandler USA entered into employment contracts with three employees of
Network in October 1995. Two of the contracts have been terminated and one
with an initial five year term remains in effect.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table lists the directors and executive officers (including
a former executive officer and director of the Company) of the Company and
provides information on their ownership of the Company's common shares at
February 28, 1998:
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP
- ---------------------------
NUMBER OF
NAME OF DIRECTOR OR EXECUTIVE OFFICER SHARES (1) PERCENT
(2)
- -------------------------------------------------- -------------
- -----------
<S> <C> <C>
W. Brent LaGere................................... 401,813 (3) 6.2%
Benjamin T. Walkingstick.......................... 401,029 (4) 6.2%
Brenda B. Watson.................................. 35,542 *
Richard L. Evans.................................. 32,750 *
Norman E. Harned.................................. 3,135,700 (5) 48.6%
Paul A. Maestri................................... - -
M.J. Moroun....................................... 3,135,700 (6) 48.6%
James M. Jacoby................................... - -
Robert L. Rice.................................... - -
Mark T. Paden..................................... 1,200 *
Ronald W. Lech.................................... 3,135,700 (5) 48.6%
Larry A. Davis.................................... - -
Steven R. Butler.................................. 1,000 *
All directors and officers as a group (13 persons) 3,964,034 61.5%
- --------------------------------------------------
* Less than 1%
<FN>
(1) Except as otherwise indicated, each person has the sole power to vote and
dispose of all shares, and the sole power to exercise any options listed
opposite his or her name.
(2) In the above table, any shares that a person can acquire through the
exercise of options are deemed to be outstanding solely for the purpose
of
computing the number and percentage of the Company's common shares that
he
or she owns. Such shares, if any, are not included in the computations
for any other person. These percentages are computed based on the number
of outstanding common shares including 1,660,125 common shares rescinded
through litigation but excluding 494,617 common shares owned by a
subsidiary of the Company which are eligible to vote. Elsewhere in this
Form 10-K, references to the number or percentage of the Company's common
shares that a person owns do not reflect common shares issuable under
outstanding options, if any.
(3) Includes (i) 348,390 common shares owned by the W. Brent LaGere
Irrevocable Trust; and (ii) 45,000 common shares owned by W&L Holding
Corp. ("W&L Holding"), a corporation 49% of which is owned by the W.
Brent
LaGere Irrevocable Trust. Mr. LaGere disclaims beneficial ownership of
the shares held by W&L Holding and the trust. The power to vote and
dispose of the shares held by W&L Holding is shared with Benjamin T.
Walkingstick, who also owns 49% of W&L Holding.
(4) Includes 45,000 common shares owned by W&L Holding, a corporation 49% of
which is owned by Mr. Walkingstick. The power to vote and dispose of the
shares held by W&L Holding is shared with the W. Brent LaGere Irrevocable
Trust, which also owns 49% of W&L Holding.
(5) Comprised of (i) 250 common shares held by Mr. Harned; (ii) 2,000 shares
held by Mr. Lech; and (iii) the other shares beneficially owned by M.J.
Moroun. See footnote (6) below and "Other Matters Regarding Beneficial
Ownership".
(6) Includes (i) 1,360,125 common shares owned by CenTra; and (ii) 1,441,700
common shares owned by Can-Am; (iii) 290,000 common shares owned by
Ammex,
Inc. ("Ammex"); (iv) 25,000 common shares owned by DuraRock, which is
owned by Matthew T. Moroun, M.J. Moroun's son; (v) 15,000 common shares
owned by Matthew T. Moroun; (vi) 250 common shares held by Mr. Harned;
(vii) 2,000 common shares held by Mr. Lech; and (viii) 1,625 common
shares
owned by Agnes A. Moroun, M.J. Moroun's sister. See "Possible Change of
Control" and "Other Matters Regarding Beneficial Ownership" regarding the
Company's assumptions about beneficial ownership and the presence of
certain restrictions on the voting and disposition of the common shares
beneficially owned by Messrs. M.J. Moroun, Harned, Lech, Agnes A. Moroun
and Matthew T. Moroun.
</TABLE>
<PAGE>
PAGE
34
SHAREHOLDERS HOLDING OVER FIVE PERCENT
Listed below are persons, other than those listed previously, who are
known by the Company to own beneficially more than 5% of the Company's common
shares as of February 28, 1998. Except as otherwise indicated, each of the
persons named below has sole voting and investment power with respect to the
common shares beneficially owned.
<TABLE>
<CAPTION>
BENEFICIAL
OWNERSHIP
- ---------------------------
NUMBER OF
NAME OF SHAREHOLDER SHARES (1)
PERCENT (2)
- -------------------------------------------------- -------------
- -----------
<S> <C> <C>
CenTra Group
(CenTra, Can-Am, Ammex and Messrs. M.J. Moroun,
Ronald Lech and Norman Harned, Agnes A. Moroun
and Matthew T. Moroun)
12225 Stephens Road, Warren, Michigan 48089........ 3,135,700 (3)
48.6%
Marvel List,(Trustee of the W. Brent LaGere
Irrevocable Trust)
420 Bennett Boulevard, Chandler, Oklahoma 74834.... 398,077
6.2%
Brinson Partners, Inc
209 S. LaSalle, Chicago, Illinois 60604............ 663,000 (4)
10.3%
- -----------------------------------------------------
<FN>
(1) Except as otherwise indicated, each person or group has the sole power to
vote and dispose of all shares and the sole power to exercise any options
listed opposite his or her name.
(2) In the above table, any shares that a person can acquire through the
exercise of options are deemed to be outstanding solely for the purpose
of
computing the number and percentage of the Company's common shares that
he
or she owns. Such shares, if any, are not included in the computations
for any other person. These percentages are computed based on the number
of outstanding common shares including 1,660,125 common shares rescinded
through litigation but excluding 494,617 common shares owned by a
subsidiary of the Company which are eligible to vote. Elsewhere in this
Form 10-K, references to the number or percentage of the Company's common
shares that a person owns do not reflect common shares issuable under
outstanding options, if any.
(3) The CenTra Group has filed a Schedule 13D with the Securities and
Exchange
Commission reporting collective beneficial ownership of 49.2% of the
Company's common shares as of July 1992. This percentage included
certain
common shares the CenTra Group had contracted to acquire subject to
regulatory approval and was calculated based on total outstanding shares
of 7,509,058. A Schedule 13D is filed by a person (or group of persons
acting collectively) who owns five percent or more of a reporting
company's stock. The beneficial ownership set forth above includes: (i)
1,360,125 common shares owned by CenTra; and (ii) 1,441,700 common shares
owned by Can-Am; (iii) 290,000 common shares owned by Ammex; (iv) 25,000
common shares owned by DuraRock, which is owned by Matthew T. Moroun,
M.J.
Moroun's son; and (v) 15,000 common shares owned by Matthew T. Moroun;
(vi) 250 common shares held by Mr. Harned; (vii) 2,000 common shares held
by Mr. Lech; and (viii) 1,625 common shares owned by Agnes A. Moroun,
M.J.
Moroun's sister.
The Company includes the ownership of Messrs. Harned and Lech and Agnes
A.
Moroun in the beneficial ownership of the CenTra Group because of their
present or former employment and other relationships with CenTra and M.J.
Moroun and their involvement in CenTra's attempts to take control of the
Company. See "Possible Change of Control" and "Other Matters Regarding
Beneficial Ownership" regarding the Company's assumptions about
beneficial
ownership and the presence of certain restrictions on the voting and
disposition of the common shares beneficially owned by Messrs. M.J.
Moroun, Harned, Lech, Agnes A. Moroun and Matthew T. Moroun.
(4) Brinson Partners, Inc. ("BPI"), an SEC registered investment advisor, is
a
wholly owned subsidiary of Brinson Holdings, Inc. ("BHI"). BHI is a
wholly owned subsidiary of SBC Holding (USA), Inc. which in turn is a
wholly owned subsidiary of Swiss Bank Corporation. The total shares
owned
by BPI represent 9.6% of the Company's outstanding voting common shares.
See Note (2) above. All of these common shares are held for the benefit
of clients of BPI. No BPI client holds more than 5% of the outstanding
voting common shares of the Company.
The business address of Mr. LaGere is 1010 Manvel Avenue, Chandler,
Oklahoma 74834. The business address for Mr. Walkingstick is 1001
Manvel
Avenue, Chandler, Oklahoma 74834. The business address of CenTra,
Can-Am,
and Messrs. M.J. Moroun and Harned is 12225 Stephens Road, Warren,
Michigan 48089. The business address of Mr. Lech is 5301 Lauren Court,
Bloomfield Hills, Michigan 48302-2941.
</TABLE>
<PAGE>
PAGE
35
OTHER MATTERS REGARDING BENEFICIAL OWNERSHIP
For purposes of this report, unless otherwise indicated, the Company has
assumed that the following persons are affiliates: an entity's executive
officers and directors or its managing partners, persons holding more than 10%
of an entity, and those persons who are controlling, controlled by, or under
common control with such officers, directors, managing partners, or
shareholders.
Statements of percentages of ownership are made based upon pertinent
reporting requirements and guidelines specifically applicable to this report
on
Form 10-K. Determination of voting power under the Company's Articles of
Association or applicable insurance holding company laws may be at variance
with the above stated percentages.
As to the beneficial ownership of its common shares, the Company has
assumed that beneficial ownership (voting and investment power) is shared
among
CenTra, Can-Am, Ammex, and Messrs. M.J. Moroun, Harned, Lech, Agnes A. Moroun
and Matthew T. Moroun. CenTra, Can-Am, Ammex and M.J. Moroun have filed a
Schedule 13D acknowledging that they compose a group formed to affect the
management practices and policies of the Company. M.J. Moroun has represented
that he is the controlling shareholder, Chairman and President of CenTra and
Ammex. Mr. Lech was, until June 2, 1995, a director and executive officer of
CenTra and continues to receive regular periodic payments from CenTra. Mr.
Harned is an executive officer of CenTra. Messrs. Harned and Lech are
executive officers and directors of Can-Am. Correspondence provided to the
Company and an amendment to the Schedule 13D described above indicate that
M.J.
Moroun is the owner of all of the outstanding voting stock of Can-Am. The
Company includes the ownership of Messrs. Harned, Lech, Agnes A. Moroun and
Matthew T. Moroun in the beneficial ownership of the CenTra Group because of
their present or former employment and other relationships with CenTra and
M.J.
Moroun and their involvement in CenTra's attempts to take control of the
Company. Each member of the group disclaims beneficial ownership or control
of
the common shares held by any other group member. They presumably would
disclaim shared beneficial ownership with either Messrs. Harned or Lech.
CenTra and its affiliates face certain restrictions in the voting or
disposition of their common shares. By resolution dated August 19, 1992, the
Company restricted the voting of common shares held by CenTra and its
affiliates, including Can-Am. In addition, voting of these shares in a manner
which would constitute a direct or indirect exercise of control over NAICO is
restricted by Nebraska law. The Nebraska Department of Insurance has
prohibited the disposition of the common shares held by Can-Am and the United
States District Court for the District of Nebraska has assumed jurisdiction
over all shares owned or controlled by M.J. Moroun and/or his affiliates.
These shares have now been tendered to and are held by the U.S. District Court
Clerk for the District of Nebraska. See "LEGAL PROCEEDINGS".
POSSIBLE CHANGE IN CONTROL
Until July 1992, CenTra and its affiliates held 22.7% of the Company's
common shares. In July 1992, M.J. Moroun attempted to obtain control of the
Company and acquired or contracted to acquire in open market and private
purchases 26.5% of the Company's common stock (which was later transferred to
Can-Am), bringing the total beneficial stock ownership of CenTra and its
affiliates to 49.2% as of July 1992. To further their purposes, CenTra or its
affiliates or both initiated litigation in Oklahoma, Arkansas, Michigan, and
an
administrative proceeding in Nebraska, the domicile of NAICO. See "LEGAL
PROCEEDINGS" and "BUSINESS--Taxation--United States Taxation of Shareholders".
To rebuff the threats posed by CenTra and its affiliates, the Company and
its subsidiaries have vigorously asserted defenses and counterclaims where
appropriate in the litigation and successfully opposed the Form A application
of CenTra and its affiliates in the administrative hearings before the
Nebraska
Department of Insurance (the "Department"). The Form A application sought the
Department's approval of M.J. Moroun's share purchases and attempted assertion
of control. CenTra and its affiliates appealed the Department's denial of
their application. The ruling of the Department and a state district court
were affirmed by the Nebraska Supreme Court on December 1, 1995. The
Department has prohibited the disposition of the common shares beneficially
owned by Can-Am (the 26.5%). By resolution dated August 19, 1992, the Company
has restricted the voting of common shares held by CenTra and its affiliates
including Can-Am. The resolution invoked the provisions of Article XI of the
Company's Articles of Association. Article XI, which was adopted by the
shareholders in 1988, prohibits business combinations lacking approval of the
Continuing Directors (those not affiliated with a 20% or more shareholder) or
80% of the shareholders and may result in a prohibition against voting such
shares held by a shareholder acquiring 20% or more of the common shares (and
its affiliates and associates) if the Continuing Directors deny approval. A
U.S. District Court Judge for the District of Nebraska has ordered the
divestiture of all CenTra shares and CenTra has delivered what it contends are
all the shares they own or control to the registry of the Court, pending the
appeal of the Court's divestiture order. The case is scheduled for oral
argument before the Eighth Circuit Court of Appeals in April 1998. If the
judgment is affirmed the Court will order a plan of divestiture. Until CenTra
can overcome these impediments, it cannot take control of the Company.
<PAGE>
PAGE
36
Despite these impediments, CenTra continues its efforts to take control
of
the Company. See "CENTRA LITIGATION--Nebraska". While the Company believes
it
has good defenses to CenTra's threats, the possibility exists that CenTra
could
ultimately prevail, could defeat the corporate resolution, and could otherwise
overcome the impediments (whether present or future) to its control. In its
Schedule 13D, CenTra asserted that if it had control it would take steps such
as reducing the number of directors, hiring a consultant to review NAICO's
operations, and increasing the internal audit staff. Based on the Company's
experience with CenTra in the CenTra insurance program and the findings of the
Nebraska Department of Insurance, the state district court and the Nebraska
Supreme Court and knowledge of CenTra's practices following other takeovers,
the Company firmly believes that CenTra's control would pose far greater
threats to the Company's shareholders and NAICO's policyholders than those
reflected in CenTra's Schedule 13D.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
One of the Company's U.S. subsidiaries leases a rural property from
Davenport Farms, Inc. ("Davenport Farms"), a corporation owned by Messrs.
Brent
LaGere, Richard Evans, Mark Paden and another employee of one of the Company's
subsidiaries. The subsidiary has placed three mobile homes on the property,
drilled a water well connected to the mobile homes and made other smaller
improvements to the property. Its personnel maintains these improvements.
These mobile homes and the property provide hunting, fishing, lodging, dining
and other outdoor recreational activities for the entertainment of customers
and business associates of Chandler USA and/or its subsidiaries. The
subsidiary pays no rent to Davenport Farms but reimburses it for one-half of
the utilities and for hunting supplies. The subsidiary has also agreed to
indemnify Davenport Farms for claims arising out of its use of the property.
The subsidiary retains the right to remove all structures located upon the
property when the lease terminates. In 1995, 1996 and 1997, the Company
incurred approximately $108,000, $184,000 and $159,000 in entertainment
expenses in connection with the use of Davenport Farms including approximately
$14,000, $7,000 and $5,000 in depreciation, and reimbursements (described
above) to Davenport Farms of approximately $8,000, $8,000 and $9,000 in each
of
those years.
On September 18, 1997, Mr. Walkingstick and L&W entered into an agreement
providing that Mr. Walkingstick will produce insurance business only through
L&W as an independent contractor (the "Insurance Agreement"). Mr.
Walkingstick
will receive one-half of all commissions upon any business he produces which
was not previously written by L&W and is liable for payment of all premiums
due
upon such business. The Insurance Agreement may be terminated at any time
upon
thirty days written notice. Upon termination, the insurance policy
expirations
or renewal rights (ownership) of the insurance business produced by Mr.
Walkingstick shall remain the property of L&W. Mr. Walkingstick is required
to
maintain his own support staff. During 1997, commissions paid to Mr.
Walkingstick under this arrangement were $10,832.
The Company's U.S. subsidiaries lease automobiles from Union National
Bank
("UNB") of which Mr. Benjamin Walkingstick is Chairman. In 1996 and 1997, UNB
received automobile lease payments of $120,000 and $128,000, and automobile
purchase payments of $53,000 and $56,000. UNB received $8,000 and $10,000 as
reimbursement for automobile tags, titles and taxes in connection with such
automobile leases in 1996 and 1997, respectively. The Company's U.S.
subsidiaries also use UNB as their principal disbursement bank. They pay no
service charges for such services but are required to maintain compensating
balances in lieu of paying service charges. The average daily amount of the
compensating balances in the aggregate was approximately $300,000 during 1997.
The balance maintained by each subsidiary is fully insured by the Federal
Deposit Insurance Corporation.
The Company believes that all transactions, including loans, with
directors, officers, or shareholders of the Company are and will continue to
be
on terms no less favorable to the Company than could be obtained from
unaffiliated parties.
ADVANCEMENT OF LITIGATION EXPENSES. In the CenTra litigation, certain
officers of the Company and the Company's directors other than Messrs. M.J.
Moroun, Harned, Lech and Maestri were named as defendants. In accordance with
its Articles of Association, the Company has 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. The Company has paid expenses totaling
approximately $2.1 million as of December 31, 1997. A portion of these
expenses relate to claims which have been dismissed or which were decided in
favor of the officers and directors. In addition, certain expenses may be
recovered from the Company's directors and officers policy insurer. As a
result of various events in 1995, the Company recorded an $818,000 estimated
recovery of costs from its directors and officers policy 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, the Company
recorded an additional estimated recovery of $982,000. The Company received a
payment for the 1995 claim during 1996 in the amount of $795,000. In
connection with the Oklahoma Federal Court judgments, the Company recorded an
additional estimated recovery of $2.7 million from the Company's directors and
officers policy insurer. The Company is entitled to a total of $5 million
under the applicable insurance policy. Some amounts have been previously paid
without dispute and the Company is negotiating with the insurer for payment of
the policy balance. The Company could recover the remaining policy limits or
could compromise its claim, and could incur significant costs in either case.
The estimated insurance recovery is based upon these variable factors. Except
for the recovery of a portion of the litigation costs from the Company's
directors and officers policy insurer, no provision has been made in the
accompanying consolidated financial statements related to the advancement of
litigation expenses to certain defendants. The Committee was delegated the
authority of the Board to deal with all issues arising from the Oklahoma
litigation including the issue of officer and director indemnification. The
Committee has retained independent counsel.
<PAGE>
PAGE
37
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. FINANCIAL STATEMENTS. The consolidated balance sheets of the
Company and its subsidiaries as of December 31, 1996 and 1997,
and the related consolidated statements of operations,
shareholders' equity and cash flows for each of the three years
in the period ended December 31, 1997, together with the related
notes thereto and the report of Deloitte & Touche, independent
auditors on such financial statements as of December 31, 1997
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 Memorandum of Association of the Company. (2)
3.2 Articles of Association of the Company and amendments
thereto. (2)(1)
4.1 Specimen Certificate for common shares of the Company. (4)
10.1Non-Qualified Stock Option Plan, as amended, adopted at the
Shareholder's Annual Meeting on January 19, 1987. (3)
10.2 Form of Non-Qualified Stock Option Agreement. (1)
10.3 Agreement for Placement of Insurance Business. (5)
22.1 List of all subsidiaries.
23.1 Deloitte & Touche consent.
-----------------------
(1) Previously filed as an exhibit to Registration No.
33-21381
on Form S-1 and incorporated herein by reference.
(2) Previously filed as an exhibit to Registration No. 33-5168
on Form S-1 and incorporated herein by reference.
(3) Previously filed as an exhibit to registrant's Annual
Report on Form 10-K for the fiscal year ended December 31,
1987 and incorporated herein by reference.
(4) Previously filed as an exhibit to Registration No.
33-33540
on Form S-2 and incorporated herein by reference.
(5) Previously filed as an exhibit to registrant's Quarterly
Report on Form 10-Q for the quarterly period ended
September 30, 1997 and incorporated herein by reference.
Copies of the foregoing exhibits filed with this Form 10-K or
incorporated by reference are available from the Company upon
written request and payment of a reasonable copying fee.
(b) Reports on Form 8-K.
The Company filed one current report on Form 8-K dated March 17,
1998
responding to Item 5 of Form 8-K.
<PAGE>
PAGE
38
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED
ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
CHANDLER INSURANCE COMPANY, LTD.
Date: March 30, 1998 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 30, 1998 /s/ W. Brent LaGere
- ----------------------------------------
W. Brent LaGere, Chairman of the
Board,
Chief Executive Officer, President
and Director
(Principal Executive Officer)
Date: March 30, 1998 /s/ Brenda B. Watson
- ----------------------------------------
Brenda B. Watson, Executive Vice
President and Director
Date: March 30, 1998 /s/ Mark T. Paden
- ----------------------------------------
Mark T. Paden, Vice President -
Finance,
Chief Financial Officer, Treasurer and
Director (Principal Accounting and
Financial Officer)
Date: March 30, 1998 /s/ Richard L. Evans
- ----------------------------------------
Richard L. Evans, Vice President -
Claims and Director
<PAGE>
PAGE
39
Date: March 30, 1998 /s/ James M. Jacoby
- ----------------------------------------
James M. Jacoby, Director
Date: March 30, 1998 /s/ Robert L. Rice
- ----------------------------------------
Robert L. Rice, Director
Date: March 30, 1998 /s/ Paul A. Maestri
- ----------------------------------------
Paul A. Maestri, Director
Date:
- ----------------------------------------
M.J. Moroun, Director
Date:
- ----------------------------------------
Norman E. Harned, Director
Date:
- ----------------------------------------
Ronald W. Lech, Director
Date: March 30, 1998 /s/ Larry A. Davis
- ----------------------------------------
Larry A. Davis, Director
<PAGE>
PAGE F-1
CHANDLER INSURANCE COMPANY, LTD.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
PAGES
- -----------------
FINANCIAL STATEMENTS
Consolidated Balance Sheets as of
December 31, 1996 and 1997............................... F-2
Consolidated Statements of Operations for the years ended
December 31, 1995, 1996 and 1997......................... F-3
Consolidated Statements of Cash Flows for the years ended
December 31, 1995, 1996 and 1997......................... F-4
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 1995, 1996 and 1997............. F-5
Notes to Consolidated Financial Statements.................... F-6 through
F-26
Independent Auditors' Report on Consolidated Financial
Statements and Financial Statement Schedules............. F-27
SCHEDULES
I Summary of Investments - Other than Investments
in Related Parties.................................. F-28
II Condensed Financial Information of Registrant............F-29 through
F-31
III Supplementary Insurance Information...................... F-32
IV Reinsurance.............................................. F-33
V Valuation and Qualifying Accounts........................ F-34
VI Supplemental Information (for property-casualty
insurance underwriters)............................. F-35
Schedules other than those listed above are omitted since the required
information is not applicable or because the information is included in the
consolidated financial statements or the notes thereon.
<PAGE>
PAGE F-2
CHANDLER INSURANCE COMPANY, LTD.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands except per share amounts)
<TABLE>
<CAPTION>
DECEMBER 31,
- -----------------------
1996 1997
----------
- ----------
<S> <C> <C>
ASSETS
Investments
Fixed maturities available for sale,
at fair value......................................$ 109,665 $
111,718
Fixed maturities held to maturity, at amortized cost
(fair value $1,675 and $1,330 in
1996 and 1997, respectively)....................... 1,582
1,222
Equity securities available for sale,
at fair value...................................... -
124
----------
- ----------
Total investments.................................. 111,247
113,064
Cash and cash equivalents................................ 7,889
11,999
Premiums receivable, less allowance for non-collection
of $177 and $115 at 1996 and 1997, respectively....... 30,413
28,079
Reinsurance recoverable on paid losses, less allowance
for non-collection of $491 and $275 in 1996
and 1997, respectively................................ 3,805
3,069
Reinsurance recoverable on unpaid losses, less allowance
for non-collection of $390 at 1997.................... 14,432
10,876
Prepaid reinsurance premiums............................. 5,470
9,662
Deferred policy acquisition costs........................ 4,993
5,312
Property and equipment, net.............................. 5,934
5,907
Other assets............................................. 11,517
12,893
Licenses, net............................................ 4,494
4,344
Excess of cost over net assets acquired, net............. 5,900
5,252
Covenants not to compete, net............................ 733
333
----------
- ----------
Total assets.............................................$ 206,827 $
210,790
==========
==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Unpaid losses and loss adjustment expenses............$ 79,639 $
74,929
Unearned premiums..................................... 36,009
42,388
Policyholder deposits.............................. 4,016
4,830
Notes payable...................................... 4,391
2,796
Accrued taxes and other payables................... 7,777
6,340
Premiums payable................................... 2,448
4,554
Litigation liabilities............................. -
16,618
----------
- ----------
Total liabilities............................... 134,280
152,455
----------
- ----------
Commitments and contingencies (Notes 10 and 11)
Shareholders' equity
Common stock, $1.67 par value, 10,000,000 shares
authorized; 6,941,708 shares issued................ 11,593
11,593
Paid-in surplus....................................... 34,942
34,942
Capital redemption reserve............................ 947
947
Retained earnings..................................... 25,951
24,886
Unrealized gain (loss) on investments available
for sale, net of tax............................... (886)
253
Less: Stock held by subsidiary, at cost
(494,617 shares)................................... -
(2,487)
Less: Stock rescinded through litigation
(1,660,125 shares)................................. -
(11,799)
----------
- ----------
Total shareholders' equity............................... 72,547
58,335
----------
- ----------
Total liabilities and shareholders' equity...............$ 206,827 $
210,790
==========
==========
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
<PAGE>
PAGE F-3
CHANDLER INSURANCE COMPANY, LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands except per share data)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- ------------------------------------
1995 1996 1997
---------- ----------
- ----------
<S> <C> <C> <C>
Premiums and other revenues
Direct premiums written and assumed......$ 98,768 $ 107,943 $
123,088
Reinsurance premiums ceded............... (14,128) (14,228)
(26,222)
---------- ----------
- ----------
Net premiums written and assumed...... 84,640 93,715
96,866
Increase in unearned premiums............ (3,553) (4,429)
(2,187)
---------- ----------
- ----------
Net premiums earned................... 81,087 89,286
94,679
Net investment income....................... 8,053 7,339
8,017
Commissions, fees and other income.......... 3,095 3,620
2,528
---------- ----------
- ----------
Total revenues........................ 92,235 100,245
105,224
---------- ----------
- ----------
Operating costs and expenses
Losses and loss adjustment expenses...... 50,543 53,391
57,512
Policy acquisition costs................. 23,995 32,123
28,145
General and administrative expenses...... 12,822 14,184
13,579
Litigation expenses, net................. 285 (108)
4,772
---------- ----------
- ----------
Total operating expenses.............. 87,645 99,590
104,008
---------- ----------
- ----------
Income before income taxes.................. 4,590 655
1,216
Federal income tax (provision) benefit
of consolidated U.S. subsidiaries........ (812) 317
(2,281)
---------- ----------
- ----------
Net income (loss)...........................$ 3,778 $ 972 $
(1,065)
========== ==========
==========
Basic and diluted earnings (loss)
per common share.........................$ 0.54 $ 0.14 $
(0.16)
========== ==========
==========
Weighted average common shares outstanding.. 6,942 6,942
6,687
========== ==========
==========
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
<PAGE>
PAGE F-4
CHANDLER INSURANCE COMPANY, LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1995 1996 1997
---------- ----------
- ----------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss)........................$ 3,778 $ 972 $
(1,065)
Add (deduct):
Adjustments to reconcile net income
(loss) to cash from operations:
Net realized gains on sale
of investments.................. (412) (140)
(764)
Net (gains) losses on sale
of equipment.................... 1 (23)
3
Amortization and depreciation...... 2,313 2,292
2,214
Provision for non-collection
of premiums..................... 124 1,768
52
Provision for non-collection
of reinsurance recoverables..... 440 2,078
527
Net change in non-cash balances
relating to operations:
Premiums receivable................ (1,575) 2,877
(1,794)
Reinsurance recoverable on
paid losses..................... (1,388) (1,250)
596
Reinsurance recoverable on
unpaid losses................... 10,691 32,197
3,169
Prepaid reinsurance premiums....... (581) (300)
(4,192)
Deferred policy acquisition costs.. 205 (1,193)
(319)
Other assets....................... 1,692 (253)
(2,456)
Unpaid losses and loss
adjustment expenses............. (27,266) (49,155)
(4,710)
Unearned premiums.................. 4,133 4,729
6,379
Policyholder deposits.............. (1,079) (468)
814
Accrued taxes and other payables... 861 2,108
(1,437)
Premiums payable................... (1,421) (524)
2,106
Litigation liabilities............. - -
4,819
---------- ----------
- ----------
Cash provided by (applied to)
operations......................... (9,484) (4,285)
3,942
---------- ----------
- ----------
INVESTING ACTIVITIES:
Fixed maturities available for sale:
Purchases............................. (32,449) (34,085)
(35,001)
Sales................................. 9,364 16,880
22,232
Maturities............................ 15,849 12,967
12,541
Fixed maturities held to maturity:
Purchases............................. (35) -
- -
Maturities............................ 17,736 4,409
380
Equity securities available for sale:
Sale.................................. - -
2,459
Cost of property and equipment
purchased............................. (802) (687)
(893)
Proceeds from sale of property and
equipment............................. 141 95
45
Other.................................... (216) (20)
- -
---------- ----------
- ----------
Cash provided by (applied to)
investing activities............... 9,588 (441)
1,763
---------- ----------
- ----------
FINANCING ACTIVITIES:
Proceeds from notes payable.............. - 4,500
- -
Payments on notes payable................ - (409)
(1,595)
---------- ----------
- ----------
Cash provided by (applied to)
financing activities.................. - 4,091
(1,595)
---------- ----------
- ----------
Increase (decrease) in cash and cash
equivalents.............................. 104 (635)
4,110
Cash and cash equivalents at beginning
of year.................................. 8,420 8,524
7,889
---------- ----------
- ----------
Cash and cash equivalents at end of year....$ 8,524 $ 7,889 $
11,999
========== ==========
==========
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
<PAGE>
PAGE F-5
CHANDLER INSURANCE COMPANY, LTD.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Dollars in thousands)
<TABLE>
<CAPTION>
UNREALIZED
GAIN STOCK TOTAL
CAPITAL
(LOSS) ON STOCK RESCINDED SHARE-
COMMON PAID-IN REDEMPTION RETAINED
INVESTMENTS, HELD BY THROUGH HOLDERS'
STOCK SURPLUS RESERVE
EARNINGS NET SUBSIDIARY LITIGATION EQUITY
------------ ------------ ------------ ------------
- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
<C> <C> <C> <C>
Balance,
January 1, 1995........$ 12,540 $ 36,143 $ - $ 22,148
$ (5,224) $ (2,148) $ - $ 63,459
Net income................ - - -
3,778 - - - 3,778
Change in unrealized gain
(loss) on investments
available for sale,
net of tax............. - - -
- - 6,213 - - 6,213
------------ ------------ ------------ ------------
- ------------ ------------ ------------ ------------
Balance,
December 31, 1995...... 12,540 36,143 -
25,926 989 (2,148) - 73,450
Net income................ - - -
972 - - - 972
Retirement of stock
held by subsidiary..... (947) (1,201) 947
(947) - 2,148 - -
Change in unrealized gain
(loss) on investments
available for sale,
net of tax............. - - -
- - (1,875) - - (1,875)
------------ ------------ ------------ ------------
- ------------ ------------ ------------ ------------
Balance,
December 31, 1996...... 11,593 34,942 947
25,951 (886) - - 72,547
Net loss.................. - - -
(1,065) - - - (1,065)
Stock acquired by
subsidiary, at cost
(494,617 shares)....... - - -
- - - (2,487) - (2,487)
Stock rescinded through
litigation (1,660,125
shares)................ - - -
- - - - (11,799) (11,799)
Change in unrealized gain
(loss) on investments
available for sale,
net of tax............. - - -
- - 1,139 - - 1,139
------------ ------------ ------------ ------------
- ------------ ------------ ------------ ------------
Balance,
December 31, 1997......$ 11,593 $ 34,942 $ 947 $ 24,886
$ 253 $ (2,487) $ (11,799) $ 58,335
============ ============ ============ ============
============ ============ ============ ============
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
<PAGE>
PAGE F-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995, 1996 AND 1997
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
(A) BASIS OF PRESENTATION
Chandler Insurance Company, Ltd. ("Chandler" or the "Company") is a
holding company organized and domiciled in the Cayman Islands. The
Company's wholly owned subsidiaries are engaged in various property
and casualty insurance and reinsurance operations. The property and
casualty insurance coverage is primarily for businesses in various
industries, political subdivisions, nonstandard private-passenger
automobiles and surety bonds for small contractors in the United
States of America ("U.S."). One of the subsidiaries principally
reinsures risks underwritten by another subsidiary. In addition, one
of the subsidiaries operates as an independent insurance agency based
in Chandler, Oklahoma, which represents various insurance companies
that provide a variety of property-casualty, life and accident and
health coverages, and acts as a surplus lines broker specializing in
risk management and brokering insurance for high risk ventures.
Operating revenues, expenses and identifiable assets are primarily
from operations outside the Cayman Islands. 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.
The consolidated financial statements have been prepared in
accordance
with United States of America generally accepted accounting
principles
("U.S. GAAP") and are expressed in U.S. dollars. 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 the
Company and all subsidiaries. The following represents the
significant subsidiaries:
> Chandler Insurance (Barbados), Ltd. ("Chandler Barbados") and
NAICO
Indemnity (Cayman), Ltd. ("NAICO Indemnity"), wholly owned
subsidiaries of the Company.
> Chandler (U.S.A.), Inc. ("Chandler USA"), a wholly owned
subsidiary
of Chandler Barbados.
> National American Insurance Company ("NAICO"), LaGere and
Walkingstick Insurance Agency, Inc. ("L&W") and Network
Administrators, Inc. ("Network"), wholly owned subsidiaries of
Chandler USA.
All significant intercompany accounts and transactions have been
eliminated in consolidation.
(C) REVENUE RECOGNITION
Premiums are generally recognized as earned on a pro rata basis over
the policy period. Commission revenues are generally recognized when
coverage is effective and premiums are billed.
(D) 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 continually reviewed and updated,
and adjustments therefrom are necessary to maintain an adequate
reserve for unpaid claims. 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 since the evaluation of
losses is inherently subjective and susceptible to significant
changing factors.
<PAGE>
PAGE F-7
(E) BASIC AND DILUTED EARNINGS (LOSS) PER COMMON SHARE
The Company has adopted Financial Accounting Standards Board ("FASB")
Statement of Financial Accounting Standards ("SFAS") No. 128,
EARNINGS
PER SHARE. Basic earnings (loss) per common share is computed based
upon net income (loss) divided by the weighted average number of
common shares outstanding during each period. The Company does not
have any preferred stock or dilutive potential common shares; as
such,
diluted earnings (loss) per common share is not applicable. The
adoption of SFAS No. 128 did not affect the previously reported
earnings per share for all periods presented.
(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,
agents' commissions 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. The Company
considers anticipated investment income in determining if a premium
deficiency exists. Certain policy acquisition costs, such as
policyholder dividends, are expensed directly. NAICO paid or accrued
$434,000, $454,000 and $1.2 million during 1995, 1996 and 1997,
respectively, for dividends to policyholders primarily on
participating workers compensation policies. Gross written premiums
for participating policies were $6.2 million, $3.2 million and $2.9
million in 1995, 1996 and 1997, respectively.
(G) PROPERTY AND EQUIPMENT
Real estate and improvements and other property and equipment are
stated at cost and depreciated using the straight-line method over
their useful lives which range from 3 years to 31 years. Asset
impairments are recorded when events or changes in circumstances
indicate that the carrying amount of assets may not be recoverable.
Property and equipment consisted of the following at December 31:
<TABLE>
<CAPTION>
1996 1997
----------
- ----------
(In thousands)
<S> <C> <C>
Real estate and improvements..........................$ 5,351 $ 5,389
Other property and equipment.......................... 7,575 7,738
----------
- ----------
12,926 13,127
Accumulated depreciation.............................. (6,992)
(7,220)
----------
- ----------
$ 5,934 $ 5,907
==========
==========
</TABLE>
(H) INTANGIBLE ASSETS
The cost of insurance licenses acquired is amortized over 40 years
using the straight-line method. Covenants not to compete are
amortized by the straight-line method over 10 years. The excess of
cost over net assets acquired is amortized by the straight-line
method
over 15-17 years. Excess of cost over fair value of net assets
acquired is written down if it is probable that estimated
undiscounted
operating income generated by the related assets will be less than
the
carrying amount. Intangible assets included the following at
December 31:
<TABLE>
<CAPTION>
1996 1997
---------- ----------
(In thousands)
<S> <C> <C>
Licenses..............................................$ 5,991 $ 5,991
Excess of cost over net assets acquired............... 10,748 10,748
Covenants not to compete.............................. 4,000 4,000
----------
- ----------
20,739 20,739
Accumulated amortization.............................. (9,612)
(10,810)
----------
- ----------
$ 11,127 $ 9,929
==========
==========
</TABLE>
<PAGE>
PAGE F-8
(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 or deductibles 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.
(J) INVESTMENTS
At the time of purchase, investments in debt securities that the
Company 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. The
Company 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 tax as a
separate component of shareholders' equity until realized.
Realized gains and losses on sales of securities are based on the
specific identification method and included in net investment income
in the accompanying consolidated statements of operations.
(K) INCOME TAXES
The Company 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, the
Company
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
and
financing activities were as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
- ------------------------------
1995
1996 1997
--------
- -------- --------
(In
thousands)
<S> <C>
<C> <C>
Cash payments during the year for:
Interest....................................$ 8 $ 141
$ 818
Income taxes................................ 864
574 1,855
Change in unrealized gain (loss) on
securities available for sale...............$ 8,224 $
(2,522) $ 1,605
Provision (benefit) for federal income taxes..... 2,011
(647) 466
--------
- -------- --------
Net increase (decrease) in shareholders' equity..$ 6,213
$(1,875) $ 1,139
</TABLE>
As allowed by authoritative accounting literature, during the period
November 15 to December 31, 1995, the Company made a one-time
reclassification of $5,442,000 of investment securities from held to
maturity to available for sale. The fair value of such securities at
the date of transfer was $5,737,000 and the unrealized gain was
$295,000. Subsequent to the reclassification but prior to December
31, 1995, the Company sold a portion of such securities having a fair
value of $5,393,000 and realized a gain of $256,000.
In the 1995 acquisition of Network, the Company acquired assets with
a
fair value of $686,000 which included $84,000 of cash and $524,000 of
goodwill associated with the acquisition. In addition, the Company
assumed or created liabilities of $386,000 which included a $300,000
note payable issued in connection with the acquisition. The
acquisition resulted in a net cash outflow to the Company of
$236,000.
<PAGE>
PAGE F-9
In January 1997, NAICO received Century Business Services, Inc.
common
stock (formerly International Alliance Services, Inc.) valued at
approximately $2.2 million at the settlement date as a result of
settling certain legal disputes with a former underwriting manager
for
the surety bond program. This amount was included in premiums
receivable at December 31, 1996.
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. See Note 2.
During 1997, ownership of 494,617 shares of the Company's common
stock
was transferred to Chandler's subsidiaries as payment for certain
debts owed by two former agents of the subsidiaries. The shares are
held as a reduction of shareholders' equity in the amount of
approximately $2.5 million. See Note 10 for additional information.
As a result of a jury verdict in April 1997, the Company recorded the
rescission of certain common stock that it sold in 1990 in return for
a future payment of $5,099,133. The rescission was recorded as a
decrease to shareholders' equity in the amount of approximately
$4,916,000 with the remaining amount included in litigation expense.
In the fourth quarter of 1997, the Company recorded the rescission of
certain additional common stock pursuant to an order issued on March
10, 1998 in the amount of $6,882,500. The payable amounts are
included in "Litigation Liabilities" on the Company's balance sheet
as
of December 31, 1997. See Note 10 for additional information.
(N) REINSURANCE
Management believes all of the Company'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 the Company from its obligation to
policyholders. In addition, failure of reinsurers to honor their
obligations could result in losses to the Company.
(O) ACCOUNTING STANDARDS ISSUED BUT NOT YET ADOPTED
In June 1997, the FASB issued SFAS No. 130, REPORTING COMPREHENSIVE
INCOME, which establishes standards for reporting and displaying
comprehensive income and its components (revenues, expenses, gains
and
losses) in financial statements. In addition, SFAS No. 130 requires
the Company to classify items of other comprehensive income by their
nature in a financial statement and display the accumulated balance
of
other comprehensive income separately in the shareholders' equity
section of the consolidated balance sheets. The Company will adopt
SFAS No. 130 on January 1, 1998 as required.
Also in June 1997, the FASB issued SFAS No. 131, DISCLOSURES ABOUT
SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION. SFAS No. 131
establishes reporting standards for public companies concerning
annual
and interim financial statements of their operating segments and
related information. Operating segments are components of a company
about which separate financial information is available that is
regularly evaluated by the chief operating decision maker(s) in
deciding how to allocate resources and assess performance. The
Standard sets criteria for reporting disclosures about a company's
products and services, geographic areas and major customers. The
Company will adopt SFAS No. 131 on January 1, 1998 as required.
NOTE 2. INVESTMENTS AND INVESTMENT INCOME
Net investment income is summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- ------------------------------
1995 1996 1997
-------- --------
- --------
(In thousands)
<S> <C> <C> <C>
TYPE OF INVESTMENT:
Interest on fixed-maturity investments...........$ 6,994 $ 6,663 $
6,680
Interest on cash equivalents..................... 647 536
573
Net realized gains - fixed - maturity
investments................................. 412 140
508
Net realized gains - equities.................... - -
256
-------- --------
- --------
$ 8,053 $ 7,339 $
8,017
======== ========
========
</TABLE>
These amounts are net of investment expenses, which are minimal.
<PAGE>
PAGE
F-10
The amortized cost and fair values of investments are as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR CARRYING
COST GAINS LOSSES VALUE VALUE
- ---------- ---------- ---------- ---------- ----------
(In thousands)
<S>
<C> <C> <C> <C> <C>
DECEMBER 31, 1996
- -----------------------------------------------------------------
FIXED MATURITIES AVAILABLE FOR SALE:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies........................ $
43,672 $ 295 $ (467) $ 43,500 $ 43,500
Debt securities issued by foreign governments....................
2,488 42 (28) 2,502 2,502
Corporate obligations............................................
43,973 141 (868) 43,246 43,246
Public utilities.................................................
15,039 78 (410) 14,707 14,707
Mortgage-backed securities.......................................
5,678 40 (8) 5,710 5,710
- ---------- ---------- ---------- ---------- ----------
$
110,850 $ 596 $ (1,781) $ 109,665 $ 109,665
========== ========== ========== ========== ==========
FIXED MATURITIES HELD TO MATURITY:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies........................ $
1,547 $ 96 $ (3) $ 1,640 $ 1,547
Corporate obligations............................................
35 - - 35 35
- ---------- ---------- ---------- ---------- ----------
$
1,582 $ 96 $ (3) $ 1,675 $ 1,582
========== ========== ========== ========== ==========
DECEMBER 31, 1997
- -----------------------------------------------------------------
FIXED MATURITIES AVAILABLE FOR SALE:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies........................ $
41,208 $ 318 $ (136) $ 41,390 $ 41,390
Debt securities issued by foreign governments....................
1,516 - (13) 1,503 1,503
Obligations of states and political subdivisions.................
20,365 167 (8) 20,524 20,524
Corporate obligations............................................
35,836 108 (213) 35,731 35,731
Public utilities.................................................
9,048 86 (42) 9,092 9,092
Mortgage-backed securities.......................................
3,449 30 (1) 3,478 3,478
- ---------- ---------- ---------- ---------- ----------
$
111,422 $ 709 $ (413) $ 111,718 $ 111,718
========== ========== ========== ========== ==========
FIXED MATURITIES HELD TO MATURITY:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies........................ $
1,222 $ 108 $ - $ 1,330 $ 1,222
========== ========== ========== ========== ==========
EQUITY SECURITIES AVAILABLE FOR SALE:
Corporate stock.................................................. $
- - $ 124 $ - $ 124 $ 124
========== ========== ========== ========== ==========
</TABLE>
During 1997, NAICO received 19,371 shares of class B common stock of the
Insurance Services Office, Inc. ("ISO") in connection with ISO's conversion to
a for-profit corporation. ISO has placed certain limitations on the transfer
or sale of the class B common stock one of which restricts ownership of the
shares to insurance companies whose primary activity is the writing of
insurance or the reinsuring of risk underwritten by insurance companies.
<PAGE>
PAGE
F-11
The maturities of investments in fixed maturities at December 31, 1997
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.....$ 19,461 $ 19,445 $ 100 $
100
Due after one year
through five years..... 37,247 37,275 267
266
Due after five years
through ten years...... 45,254 45,451 855
964
Due after ten years......... 6,011 6,069 -
- -
---------- ---------- ----------
- ----------
107,973 108,240 1,222
1,330
Mortgage-backed securities,
which are subject to
prepayments............ 3,449 3,478 -
- -
---------- ---------- ----------
- ----------
$ 111,422 $ 111,718 $ 1,222 $
1,330
========== ========== ==========
==========
</TABLE>
Realized gains and losses from sales of fixed maturities and equity
securities are shown below:
<TABLE>
<CAPTION>
GROSS GROSS
REALIZED REALIZED
GAINS LOSSES
----------
- ----------
(In thousands)
<S> <C> <C>
1995..................................................$ 419 $
7
1996.................................................. 178
38
1997.................................................. 803
39
</TABLE>
Chandler Barbados is required as a foreign reinsurer to secure reserves
for unpaid losses and loss adjustment expenses and unearned premiums for the
benefit of the primary insurer ceding such amounts. Chandler Barbados secures
such amounts with trust arrangements whereby securities are deposited into a
trust account for the benefit of the primary insurer, and by using irrevocable
bank letters of credit which are secured by certificates of deposit and other
fixed-income investments. At December 31, 1996 and 1997, Chandler Barbados had
investments with a fair value of $19,373,000 and $16,682,000, respectively,
deposited in a trust account for the benefit of NAICO.
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, 1996 and 1997, the carrying value of these deposits totaled $10,318,000
and
$8,246,000, respectively. NAICO is also required to deposit securities into a
trust account related to reinsurance agreements. As of December 31, 1996 and
1997, the fair value of these deposits totaled $211,000 and $212,000,
respectively.
At December 31, 1997 the total amount of cash and investments restricted
as a result of these arrangements was $25,140,000.
NOTE 3. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
The Company 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,
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 the Company's net liability for losses and loss adjustment expenses were
approximately $3,615,000 and $3,809,000 at December 31, 1996 and 1997,
respectively. Although such estimates are management's best estimates of the
expected values, the ultimate liability for unpaid claims may vary from these
values. The Company does not discount the liability for unpaid losses and
loss
adjustment expenses.
<PAGE>
PAGE
F-12
The following table sets forth a reconciliation of the beginning and
ending unpaid losses and loss adjustment expenses which are net of reinsurance
deductions.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- ------------------------------------
1995 1996 1997
---------- ----------
- ----------
(In thousands)
<S> <C> <C> <C>
Net balance before provision for
uncollectible reinsurance at
beginning of year.......................$ 97,894 $ 81,388 $ 64,430
---------- ----------
- ----------
Net losses and loss adjustment expenses
incurred related to:
Current year............................ 50,975 53,314 53,704
Prior years............................. (432) 77 3,808
---------- ----------
- ----------
Total................................ 50,543 53,391 57,512
---------- ----------
- ----------
Net paid losses and loss adjustment
expenses related to:
Current year............................ (21,106) (23,836)
(22,214)
Prior years............................. (45,943) (46,513)
(36,838)
---------- ----------
- ----------
Total................................ (67,049) (70,349)
(59,052)
---------- ----------
- ----------
Net balance before provision for
uncollectible reinsurance............... 81,388 64,430 62,890
Adjustments to reinsurance recoverables
on unpaid losses for uncollectible
reinsurance............................. 629 777 1,163
---------- ----------
- ----------
Net balance at end of year.................$ 82,017 $ 65,207 $ 64,053
========== ==========
==========
</TABLE>
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 clean-up and restoration of damage resulting
from sudden and accidental release or discharge of contaminants or other
substances which may be classified as pollutants. NAICO also provides surety
bonds for construction contractors who use or have control of such substances
and for contractors who remove and dispose of asbestos as a part of their
contractual obligations. NAICO also insures independent oil and gas producers
who may purchase coverage for the escape of oil, saltwater, or other
substances
which may be harmful to persons or property, but may not generally be
classified as pollutants. Chandler Barbados reinsures a portion of those
risks. The Company 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 the Company, 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
financial
condition or results of operations of the Company.
NOTE 4. NOTES PAYABLE
During 1996, Chandler USA entered into a three year loan agreement with a
bank having a principal amount of $4,500,000 and a floating interest rate at
Wall Street Journal Prime. Monthly payments were $142,000 including principal
and interest. Among other things, the loan agreement precludes Chandler USA
from paying shareholder dividends, issuing stock and limits indebtedness.
Moreover, the loan agreement requires that certain restrictive covenants be
met. At December 31, 1997, Chandler USA was in compliance with all financial
covenants. Proceeds from the note were used to repay intercompany advances
from Chandler Barbados. 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 Wall Street Journal Prime, which was 8.5% at December 31,
1997. The revised monthly payment is approximately $179,000 including
principal and interest. The principal balance of the note was approximately
$4,166,000 and $2,646,000 at December 31, 1996 and 1997, respectively. The
principal balance at December 31, 1997 is net of an unamortized loan
origination fee of $82,000. All or a portion of the available borrowing
capacity under the note may be used to post needed bonds or to discharge
litigation judgments. The bank note is collateralized by the shares of NAICO
stock owned by Chandler USA.
Chandler USA has a note payable related to the acquisition of Network
with
a balance of $225,000 and $150,000 at December 31, 1996 and 1997,
respectively.
The note has an interest rate of 7% and is payable in annual installments of
$75,000 plus interest on October 11, 1998 and 1999.
<PAGE>
PAGE
F-13
In February 1998, Chandler USA entered into a five year loan agreement
with a bank having a principal amount of $2,300,000 and an interest rate of
7.75%. Monthly payments are $46,482 including principal and interest. The
loan is collateralized by certain equipment which was purchased with the
proceeds of the loan. The equipment had previously been leased by Chandler
USA.
The annual maturities of the notes payable, based upon the amounts
borrowed as of December 31, 1997 and including the February 1998 loan, are as
follows:
<TABLE>
<CAPTION>
(In thousands)
<S> <C>
1998..............................$ 2,376
1999.............................. 1,251
2000.............................. 453
2001.............................. 490
2002.............................. 529
Thereafter........................ 79
-------
$ 5,178
=======
</TABLE>
NOTE 5. SHAREHOLDERS' EQUITY
CAPITAL STOCK
On May 7, 1988, the Company's shareholders authorized the issuance of up
to 3,000,000 preferred shares with a par value of $1.00. No preferred shares
have been issued as of December 31, 1997.
The provisions of Article XI of the Company's Articles of Association,
which was adopted by the shareholders in 1988, prohibits business combinations
lacking approval of the Continuing Directors (those not affiliated with a 20%
or more shareholder) or 80% of the shareholders and may result in a
prohibition
against voting such shares held by a shareholder acquiring 20% or more or the
common shares (and its affiliates and associates) if the Continuing Directors
deny approval. In addition to the regulatory oversight of NAICO by the
Nebraska Department of Insurance, the Company is also subject to regulation
under the Nebraska Insurance Holding Company Systems Act (the "Holding Company
Act"). In addition to various reporting requirements imposed on the Company,
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 the Company'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.
In 1996, the Company acquired 567,350 shares of its stock previously held
by Chandler USA and retired the shares. In accordance with the Companies Law
(1995 Revision) of the Cayman Islands, the Company established the capital
redemption reserve fund in the amount of $947,000 which is reflected as a
component of shareholders' equity in the consolidated balance sheets as of
December 31, 1996 and 1997.
See Note 10 regarding stock held by a subsidiary of the Company and stock
rescinded through litigation.
Under Section 953(c) of the Internal Revenue Code of 1986 as amended (the
"Code"), if U.S. persons indirectly own (i.e., through ownership of the
Company) 25% or more of the total combined voting power of all classes of
Chandler Barbados' stock entitled to vote or 25% or more of the total value of
Chandler Barbados' stock, then each such person is required to include in his
gross income a portion of any insurance income of Chandler Barbados
attributable to a policy of insurance or reinsurance with respect to which the
person (directly or indirectly) insured is a related person to a shareholder
in
Chandler Barbados ("related person insurance income" or "RPII"). Under these
rules, all U.S. persons who own stock in the Company (including Chandler's
U.S.
subsidiaries) would generally be required, subject to the exception discussed
hereinafter, to include in their gross incomes a portion of the RPII received
by Chandler Barbados from NAICO. However, related person insurance income of
Chandler Barbados need not be included in the income of a U.S. person who is
not a "United States shareholder," as defined in Section 951(b) of the Code,
if, at all times during Chandler Barbados' taxable year, less than 20% of the
total combined voting power of all classes of stock of Chandler Barbados and
less than 20% of the total value of Chandler Barbados is owned (directly or
indirectly) by persons who are (directly or indirectly) insured under any
policy of insurance or reinsurance issued by Chandler Barbados, or who are
related persons to any such person.
See Note 7 regarding possible taxation of certain income of the Company
to
U.S. shareholders with certain ownership percentages.
<PAGE>
PAGE
F-14
STATUTORY FINANCIAL INFORMATION AND MINIMUM CAPITAL REQUIREMENTS
Chandler, Chandler Barbados, NAICO Indemnity and NAICO are required to
file financial statements with insurance regulatory authorities. Chandler and
NAICO Indemnity file financial statements with The Monetary Authority in the
Cayman Islands, and Chandler Barbados files financial statements with the
Supervisor of Insurance in Barbados. NAICO is required to file financial
statements with state regulatory authorities prepared on a statutory basis
which differs from U.S. GAAP. Statutory net income and statutory surplus of
NAICO are as follows:
<TABLE>
<CAPTION>
1995 1996 1997
---------- ----------
- ----------
(In thousands)
<S> <C> <C> <C>
Statutory net income.......................$ 1,123 $ 998 $
6,737
Statutory surplus..........................$ 40,594 $ 42,373 $
45,283
</TABLE>
Chandler, NAICO Indemnity and Chandler Barbados are also required to
maintain net worth subject to minimum requirements imposed by the applicable
regulatory authorities. Chandler and NAICO Indemnity are required to maintain
a
net worth of the greater of (i) $120,000, or (ii) an amount equal to 20% of
their net premiums earned. Chandler Barbados must have assets exceeding
liabilities by (i) $125,000 where the premium income in the previous year did
not exceed $750,000; or (ii) 20% of the premium income for the preceding year
where the premium income exceeded $750,000 but did not exceed $5,000,000; or
(iii) the aggregate of $1,000,000 and 10% of the amount by which the premium
income in that fiscal year exceeded $5,000,000.
The National Association of Insurance Commissioners has adopted
risk-based
capital ("RBC") standards for domestic property-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, 1996 and 1997.
At periodic intervals, various insurance regulatory authorities routinely
examine the required financial statements 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
As a holding company, the Company may receive cash through equity sales,
borrowings and dividends from its subsidiaries. Chandler Barbados and NAICO
are
subject to regulations which restrict their ability to pay shareholder
dividends. The payment of cash shareholder dividends by Chandler Barbados to
the Company is limited to its earned surplus (approximately $38.0 million at
December 31, 1997) and margin of solvency requirements. 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 1998 without the approval of the Nebraska Department
of Insurance is approximately $8.1 million.
The payment of shareholder dividends depends upon the earnings, financial
position and cash requirements of the Company, as well as regulatory
limitations, including such other factors as the Board of Directors may deem
relevant. Chandler Barbados and NAICO (during the ownership by the Company)
have not paid any cash shareholder dividends as of December 31, 1997.
NAICO is subject to regulations which restrict its ability to pay
dividends to policyholders. The maximum amount of available policyholder
dividends is limited to statutory earned surplus (approximately $12.6 million
as of December 31, 1997). NAICO paid approximately $452,000, $526,000 and
$423,000 in policyholder dividends during 1995, 1996 and 1997, respectively.
See Note 4 regarding a bank loan which precludes Chandler USA from paying
shareholder dividends.
NOTE 6. STOCK OPTIONS AND WARRANTS
The Company has a non-qualified stock option plan (the "Plan") for which
the Company has reserved an aggregate of 968,750 shares of its common stock
subject to adjustment for reorganizations, recapitalizations, stock splits or
similar events, for issuance upon exercise of options to be granted under the
Plan. Options are granted at a purchase price of the fair market value as of
the grant date. Shares of common stock subject to the unexercised portions of
any options granted under the Plan which terminate or are canceled may again
be
subject to reissuance under the Plan. Officers of the Company and its
subsidiaries are eligible to receive options under the Plan. The Plan is
administered by a committee of the Company's outside directors appointed by
the
Board of Directors of the Company.
No stock options or warrants were outstanding from January 1, 1995
through
December 31, 1997.
<PAGE>
PAGE
F-15
NOTE 7. INCOME TAXES
Chandler, Chandler Barbados and NAICO Indemnity have received tax
concessions from the Cayman Islands and Barbados governments for all taxes
levied on profits, income, gains and appreciation that are valid through
September 30, 2003, May 19, 2003 and March 10, 2012, respectively.
Accordingly, no income taxes have been provided. The companies do not
consider
themselves engaged in a trade or business within the United States and
therefore are not subject to United States Federal income tax. Should the
Internal Revenue Service ("IRS") determine that any of the companies are
engaged in a trade or business within the United States and has not filed a
federal income tax return, such company may be subject to federal income tax
and may not be allowed any deductions or credits in determining its tax
liability.
In late 1994 the IRS proposed increases in federal income tax and the
imposition of federal withholding tax and penalties payable by Chandler USA
and
its wholly owned subsidiaries for calendar years 1989 through 1992 in the
approximate amount of $2.5 million plus interest. The proposed adjustments to
the federal income tax liability were attributable in part to a proposed
increase in the income of Chandler USA for calendar year 1992 in the amount of
$348,000 which, the IRS asserted, was Chandler USA's share of the Company's
subpart F income for that year. The remaining proposed increase in income tax
arose from the disallowance of deductions for certain expenses (primarily
litigation costs - see Note 10), incurred by Chandler USA in calendar years
1991 and 1992, and the subsequent disallowance of a net operating loss
carryback to calendar years 1989 through 1991. The proposed withholding tax
assessment arose out of an assertion by the IRS that certain of the non-
deductible expenses were incurred for the benefit of the Company, that they
should be treated as a deemed distribution by Chandler USA to the Company, and
as such should be subject to a 30% U.S. withholding tax. Chandler USA did not
agree with the adjustments and filed a written protest of the proposed
adjustments on December 23, 1994.
The IRS contended that Chandler Barbados did not qualify for the
exception
to the inclusion of RPII for all U.S. persons who hold the Company's stock,
because the Company owns more than 20% of the voting power and value of
Chandler Barbados, and the Company is a related party to NAICO, which
purchases
reinsurance from Chandler Barbados. However, the Company believes, and
asserted to the IRS that U.S. persons who hold less than 5.5% of the stock of
the Company should not be required to include any RPII of Chandler Barbados in
their income. The IRS has agreed with the Company's position on this issue,
and a formal closing agreement was executed in 1996.
During the fourth quarter of 1995, after numerous discussions and
preliminary consensus with the IRS, Chandler USA made a provision for possible
assessments of additional taxes through 1992 and additional taxes attributable
to amended returns for 1993 and 1994 in the amount of $536,000. During 1996,
the IRS and Chandler USA executed a formal closing agreement, Chandler USA
paid
the taxes for the open tax years (1989 through 1994) and the IRS closed its
examination.
During 1996, the IRS conducted a field examination of the U.S. Federal
income tax returns of Chandler USA and its wholly owned subsidiaries for the
years 1993 and 1994. The IRS completed the examination in the fourth quarter
of 1996. Chandler USA has been informed by the IRS that there are no proposed
adjustments to tax liabilities.
Chandler USA and its wholly owned subsidiaries file a consolidated U.S.
Federal income tax return. The income taxes reflected in the accompanying
consolidated statements of operations differs from that expected using U.S.
Federal enacted income tax rates for the following reasons:
<TABLE>
<CAPTION>
1995 1996 1997
---------- ----------
- ----------
(In thousands)
<S> <C> <C> <C>
Computed tax expense at 34%................$ 1,561 $ 223 $ 413
Increase (decrease) in income
taxes resulting from:
Expense (benefit) from income (loss) not
subject to U.S. Federal income tax..... (2,086) (943)
1,384
Amortization of licenses and
other intangibles...................... 368 380 380
Tax on 1995 subpart F income............. 114 - -
Settlement of U.S. Federal income tax
liability through 1992 and adjustments
to prior years' accruals............... 724 - -
Nontaxable income from legal settlement.. - (110)
- -
Other, net............................... 131 133 104
---------- ----------
- ----------
Federal income tax provision (benefit).....$ 812 $ (317) $ 2,281
========== ==========
==========
</TABLE>
<PAGE>
PAGE
F-16
U.S. Federal income tax expense (benefit) consists of:
<TABLE>
<CAPTION>
CURRENT DEFERRED TOTAL
---------- ----------
- ----------
(In thousands)
<S> <C> <C> <C>
1995.......................................$ 845 $ (33) $
812
1996....................................... (592) 275
(317)
1997....................................... 2,389 (108)
2,281
</TABLE>
Deferred tax expense (benefit) relating to temporary differences includes
the following components:
<TABLE>
<CAPTION>
1995 1996 1997
---------- ----------
- ----------
(In thousands)
<S> <C> <C> <C>
Loss reserve discounts.....................$ 174 $ 450 $
(97)
Unearned premiums.......................... (250) (292)
(58)
Deferred policy acquisition costs.......... 20 158 1
Reserve for uncollectible accounts......... (153) 45 188
Depreciation and lease expense............. 21 (134)
(164)
Other...................................... 155 48 22
---------- ----------
- ----------
$ (33) $ 275 $
(108)
========== ==========
==========
</TABLE>
The tax effect of temporary differences between the consolidated
financial
statements 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>
1996 1997
----------
- ----------
(In thousands)
<S> <C> <C>
Deferred tax assets:
Loss reserve discounts...............................$ 3,597 $ 3,694
Unearned premiums.................................... 1,767 1,825
Reserve for uncollectible accounts................... 227 39
Unrealized loss on investments available for sale.... 299 -
Net operating loss carryforwards - State............. 1,361 1,559
Other................................................ 128 106
Valuation allowance..................................... (1,361)
(1,559)
----------
- ----------
Total deferred tax assets............................... 6,018 5,664
----------
- ----------
Deferred tax liabilities:
Deferred policy acquisition costs.................... 1,180 1,181
Depreciation and lease expense....................... 907 743
Unrealized gain on investments available for sale.... - 166
----------
- ----------
Total deferred tax liabilities.......................... 2,087 2,090
----------
- ----------
Net deferred tax asset..................................$ 3,931 $ 3,574
==========
==========
</TABLE>
At December 31, 1997 Chandler USA had available for Oklahoma state tax
purposes net operating loss carryforwards totaling approximately $26 million
which expire in the years 2004 through 2013. A valuation allowance has been
provided for the tax effect of the state net operating loss carryforwards
since
realization of such amounts is not assured.
NOTE 8. EMPLOYEE BENEFITS
Chandler USA and subsidiaries participate in a defined contribution
retirement plan established under Section 401(k) of the Code. All full time
employees who meet certain eligibility requirements may elect to participate
in
the 401(k) plan. Participants may contribute up to 15% of compensation, not
to
exceed $9,500 per year as indexed. During 1995, Chandler USA matched 50% of
employee contributions up to a maximum employer contribution of $1,000 per
year
per employee. Beginning January 1, 1996, the Company matched 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 $3,475 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 $402,000, $249,000 and $254,000 for 1995, 1996
and 1997, respectively.
<PAGE>
PAGE
F-17
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 the Company, 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 the Company could
realize in a current market exchange. The use of different market assumptions
and/or estimation methodologies may have a material effect on the estimated
fair value amounts.
A number of the Company'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. The Company has concluded
that the carrying value of other assets and liabilities considered financial
instruments such as cash, premiums receivable, policyholder deposits, accrued
taxes and other payables, notes payable and premiums payable approximates
their
fair value as of December 31, 1996 and 1997. The estimated fair values of the
Company's fixed-maturity and equity security investments are disclosed at
Note 2.
NOTE 10. LITIGATION
CENTRA LITIGATION -- GENERAL BACKGROUND
CenTra is a Detroit-based holding company primarily engaged in the
trucking industry. Beginning in 1987, NAICO insured CenTra's automobile
liability, general liability and workers compensation risks through
reinsurance
arrangements involving DuraRock Underwriters, Ltd. ("DuraRock"), a Barbados
company and an affiliate of CenTra, its predecessor Can-Am Underwriters, Ltd.
("Can-Am") and Chandler Barbados. In addition to the insurance arrangements,
CenTra and its affiliates have been significant shareholders in the Company
(holding approximately 22.7% of the Company's common stock at July 1, 1992).
Three present or former executive officers of CenTra, Norman E. Harned, Ronald
W. Lech and M. J. Moroun, are directors of the Company.
Beginning in 1992, the relationships between the Company and CenTra
deteriorated largely due to differences about the CenTra insurance program,
CenTra's failure to make timely premium payments and CenTra's role in an
anticipated management-led tender offer. In an apparent attempt to block the
tender offer and seize control of the Company, CenTra began, on July 1, 1992,
a
series of common stock purchases and offers to purchase that would, over the
following two weeks, place almost one-half of the Company's common stock with
CenTra and its affiliates. On July 1 and 2, 1992, CenTra made an offer to
Chandler USA, an indirect subsidiary of the Company, to purchase 1,117,679
common shares. These common shares were either owned by Chandler USA (567,350
common shares) or pledged to a subsidiary and owned by Cactus Southwest Corp.
(169,858 common shares) or the Universal Insurance Group (380,471 common
shares). Chandler USA declined the offer. On July 2, 1992, NAICO and NAICO
Indemnity canceled the CenTra insurance policies for non-payment of premiums
effective September 5, 1992. On July 2, 1992, CenTra made an offer to Cactus
Southwest Corp. to purchase 169,858 common shares owned by it but pledged to
the Chandler USA subsidiary to collateralize certain receivables. On July 7,
1992, the Nebraska Department of Insurance (the "Department") ordered CenTra
to
cease and desist purchases of the Company's common shares. On July 9, 1992,
M.J. Moroun withdrew CenTra's prior offer to Cactus Southwest Corp. and
offered
to purchase the same common shares himself. At the same time, he began
purchasing common shares in the open market. On July 10, 1992, the Department
ordered CenTra and its affiliates and Messrs. M.J. Moroun, Harned and Lech to
cease and desist purchases of the Company's common shares. On the same date,
M.J. Moroun made an offer to the Universal Insurance Group to purchase 380,471
common shares owned by it but pledged to the Chandler USA subsidiary, and M.J.
Moroun made further open market purchases. On July 11, 1992, M.J. Moroun paid
$100,000 to the Universal Insurance Group for an irrevocable proxy and
contracted with it for the purchase of its pledged common shares. On July 12,
1992, M.J. Moroun contracted with Cactus Southwest Corp. for the purchase of
its pledged common shares. On July 13, 1992, further open market purchases
were made in the name of Can-Am, a not-yet-formed Bahamian affiliate of
CenTra.
Also on July 13, 1992, the District Court for Lancaster County, Nebraska
entered a temporary restraining order against CenTra, Messrs. M.J. Moroun,
Harned and Lech, John and Jane Doe, XYZ Corporation, and their affiliates
known
and unknown, prohibiting further purchases. On July 14 and 17, 1992, the
stock
brokerage firm through which the open market purchases were made purportedly
substituted Can-Am for M.J. Moroun as the purchaser on the July 9 and 10 sales
confirmations. At some time after July 13, 1992, M.J. Moroun assigned his
rights to purchase the pledged shares of the Universal Insurance Group and
Cactus Southwest Corp. to Can-Am; neither CenTra nor Can-Am now claim
ownership
or any interest in the shares. During the second quarter of 1997, ownership
of
380,471 shares was transferred to a Chandler subsidiary as payment for one of
the agent's debts. In December 1997, 114,146 shares were transferred to a
Chandler subsidiary and the balance of the pledged shares were transferred to
unaffiliated persons and entities. These transactions had the effect of
canceling the debts secured by the shares. The shares are held as a reduction
of shareholders' equity.
<PAGE>
PAGE
F-18
Through the above transactions, CenTra and its affiliates acquired, or
contracted to acquire, an additional 26.5% of the Company's common stock,
bringing their total claimed stock ownership to 49.2% in July 1992. The
tender
offer, which commenced on July 9, 1992 without knowledge of the open market
purchases, was withdrawn on July 23, 1992. As these developments unfolded,
CenTra or its affiliates or both initiated litigation in Oklahoma, Arkansas
and
Michigan, and an administrative proceeding in Nebraska, the domicile of NAICO.
CENTRA LITIGATION -- OKLAHOMA
BACKGROUND OF OKLAHOMA LAWSUIT. On July 16, 1992, CenTra and Messrs.
M.J.
Moroun, Lech and Harned filed a lawsuit in the United States District Court
for
the Western District of Oklahoma against the Company, the other corporations
participating in the tender offer, and various individuals including certain
officers and employees of the Company and its subsidiaries and the remaining
directors of the Company, except Mr. Paul Maestri. The lawsuit sought
declaratory and injunctive relief to prevent the tender offer alleging
breaches
of fiduciary and other duties and violations of the federal securities laws.
After the tender offer was withdrawn, the plaintiffs amended their complaint
on
August 5, 1992, alleging breaches of fiduciary and other duties by commencing
the tender offer and violations of federal securities laws in the tender offer
and in certain transactions since 1988. The Company and the other defendants
denied any breaches of duty or violations of law and the Company filed
various
counterclaims against CenTra and various affiliates alleging breaches of
fiduciary duties and violations of federal securities laws in their attempts
to
seize control of the Company through the July 1992 stock purchases, and sought
damages, costs and attorney fees. The Company also asserted a counterclaim
against M.J. Moroun, individually, based upon his alleged violation of Section
16(b) of the Securities Exchange Act of 1934 regarding "short swing" profits.
On January 6, 1993, the plaintiffs filed a second amended complaint (i)
asserting violations of federal securities laws and a breach of contract claim
in a 1988 stock purchase; (ii) asking the court to declare invalid and
unenforceable a corporate resolution based on Article XI of the Company's
Articles of Association (prohibiting certain business combinations) that
prohibits Can-Am and its affiliates (including CenTra) from voting their
shares
of the Company's common stock; and (iii) asserting derivative claims for
fiduciary misconduct, unjust enrichment, fraud and/or breach of contract in
the
tender offer, for management bonuses in 1988 and 1989, in the Company's
purchase of three management-related agencies in 1988, and for assorted
improper personal benefits. All of these derivative claims seek unspecified
damages, restitution and/or injunctive relief on behalf of the Company,
including punitive damages, attorneys' fees and costs. In 1994 the plaintiffs
made a request to file a third amended complaint. The Court denied that
request.
A three member committee ("Special Committee"), who are on the board of
directors of NAICO and are not named in the lawsuits, investigated the
derivative claims. The Special Committee concluded the Company should take no
action against the individual defendants regarding the claims relating to the
tender offer, the management bonuses and the agency purchases. As to the
allegedly improper personal benefits, the Special Committee found that some
were ordinary and necessary business expenses while others were not. The
Special Committee recommended that the recipients reimburse the Company or the
affected subsidiaries for all improper personal benefits, the full value of
which was $135,000. The respective Boards of Directors of the Company and the
affected subsidiaries accepted the report and recommendations of the Special
Committee and retained special legal counsel to implement the recommendations
of the Special Committee. Messrs. M.J. Moroun, Lech and Harned dissented.
On July 20, 1992, CenTra sued NAICO in the Circuit Court of Macomb
County,
Michigan alleging that NAICO and certain officers and directors wrongfully
canceled insurance policies issued to CenTra. CenTra claimed that the
cancellation was retaliation for CenTra's decision not to participate in the
tender offer, requested that the policies be reinstated, and sought monetary
damages for the wrongful cancellation. The case was removed to the U.S.
District Court for the Eastern District of Michigan. NAICO replied that the
cancellation was proper based on CenTra's continuing failure to pay premiums.
After two extensions of the cancellation date, the policies were canceled
effective on September 5, 1992 after CenTra acquired replacement insurance.
On
August 26, 1992, CenTra deposited $700,000 with the court clerk under court
order as security for premiums due under the NAICO policies. On October 13,
1992, the court granted defendants' motion to transfer the action to the U.S.
District Court for the Western District of Oklahoma. On January 27, 1993,
plaintiff filed an application in the Court of Appeals for the Sixth Circuit
contending that the district court abused its discretion by transferring the
case to Oklahoma. The application was denied. CenTra then filed a motion in
the U.S. District Court in Oklahoma to transfer the case to Michigan. The
U.S.
District Court in Oklahoma retained jurisdiction of the case. NAICO filed a
claim seeking payment of the unpaid premiums and contended that the
cancellations were proper and denied that CenTra suffered any damages as a
result of the cancellations, or any action taken by NAICO associated with the
cancellations.
OKLAHOMA JUDGMENTS - APRIL 22, 1997, MARCH 10, 1998. On February 13,
1997, trial commenced in the United States District Court in Oklahoma City,
Oklahoma (the "Oklahoma Federal Court") in the consolidated cases involving
CenTra and certain of its affiliates, officers and directors (the "CenTra
Group") and the Company and certain of its affiliates, officers and directors.
On April 1, 1997, at the close of all of the evidence, the Court entered
judgment in favor of NAICO on CenTra's claims for alleged wrongful
cancellation
of CenTra's insurance with NAICO and the affiliate in 1992. See CenTra
Litigation - Other. The remaining issues were submitted to a jury.
<PAGE>
PAGE
F-19
On April 9, 1997, the jury returned verdicts on all claims. On April 22,
1997, the Oklahoma Federal Court entered judgments on all verdicts returned.
One judgment against the Company requires the CenTra Group to return stock it
purchased in 1990 to the Company in return for a payment of $5,099,133 from
the
Company. Another judgment was against both the Company and its affiliate
Chandler Barbados and in favor of CenTra and its affiliate Ammex, Inc. Based
upon an alleged breach of a stock purchase agreement in 1988, CenTra and Ammex
were awarded $6,882,500. Both judgments related to alleged failures by the
Company to adequately disclose the fact that ownership of the Company's stock
may be subject to regulation by the Nebraska Insurance Department under
certain
circumstances. The jury also found in favor of CenTra and against certain
officers and/or directors of the Company on the securities claims relating to
CenTra's 1990 purchases and the failure to disclose the application of
Nebraska insurance law, but awarded damages of $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. 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.
On other claims asserted by the CenTra Group, the jury found in favor of
the Company and/or the individual defendants. The jury also found in favor of
NAICO and NAICO Indemnity on their counterclaims for CenTra's failure to pay
insurance premiums in the sum of $788,625 and further upheld a resolution
adopted by the Chandler Board of Directors in August 1992 pursuant to Article
XI of the Company's Articles of Association preventing CenTra and its
affiliates from voting their Chandler stock as a result of purchases made by
the CenTra Group in July 1992 as part of its efforts to acquire control of
Chandler.
The jury found in favor of CenTra on the Company's claim against CenTra
for breach of a standstill agreement contained in a 1988 stock exchange
agreement. The jury denied the Company's claim against Messrs. Harned, Lech
and Moroun based upon their alleged breach of fiduciary duty as directors.
The
jury also denied the Company's claim against Mr. Moroun individually for
violation of Section 16(b) of the Securities Exchange Act of 1934 regarding
short swing profits.
Several post-trial motions were filed by all parties relating to the
judgments and prejudgment interest. The Oklahoma Federal Court ordered that
additional motions for costs and attorney fees be filed within 20 days
following rulings on these motions. However, on October 11, 1997 CenTra filed
motions for costs and attorneys fees totaling $4.7 million. The Company
responded by contending that the motions were filed prematurely and are, in
any
event, without merit.
As a result of the Oklahoma Federal Court judgments, the Company recorded
a net charge for the litigation matters described above during the first
quarter of 1997 totaling approximately $8.3 million ($8.5 million including
provision for federal income tax). In addition, the Company recorded the
return of 517,500 shares of the Company's stock in conjunction with the stock
rescission judgment as a decrease to shareholders' equity in the amount of
approximately $4.9 million with the remaining amount included in the charge
for
litigation matters. The charge includes approximately $4.6 million as an
estimate of interest, costs and related attorney fees. The charge includes an
estimated recovery of $2.7 million from the Company's directors and officers
policy insurer for costs associated with the defense and litigation of these
matters. The Company is entitled to a total of $5 million under the
applicable
insurance policy. Some amounts have been previously paid without dispute and
the Company is negotiating with the insurer for payment of the policy balance.
The Company could recover the remaining policy limits or could compromise its
claim, and could incur significant costs in either case. The estimated
insurance recovery is based upon these variable factors. The charge also
includes the amount of judgments in favor of Chandler USA on the derivative
claims discussed above. Except for the recovery of a portion of the
litigation
costs from the Company's directors and officers policy insurer, no provision
has been made in the accompanying consolidated financial statements related to
the advancement of litigation expenses to certain defendants.
On March 10, 1998, the Oklahoma Federal Court disposed of all post-trial
motions filed by the parties. The parties had asked the Oklahoma Federal
Court
to vacate or modify judgments unfavorable to them and requested the Oklahoma
Federal Court to award prejudgment interest. The Oklahoma Federal Court
overruled all pending motions except a motion by the Company and Chandler
Barbados to require CenTra and its affiliates to deliver 1,142,625 Shares of
Chandler common stock they own or control upon payment of the $6,882,500
judgment which was entered in CenTra's favor in April 1997. The Company has
recorded the return of 1,142,625 shares of the Company's stock in conjunction
with the order as a decrease to shareholders' equity as of December 31, 1997,
and reduced the previous first quarter of 1997 net charge for litigation
matters by $6,882,500. The CenTra parties were directed to deliver the shares
upon payment of the judgment. CenTra's pending motion for an award of costs
and attorney fees was stricken and all parties were granted leave to file such
motions within 20 days of March 10, 1998. On March 16, 1998 CenTra and its
affiliates filed such motions seeking an award of costs and attorney fees
totaling approximately $4.7 million. All parties may appeal any or all of the
orders of the Oklahoma Federal Court. On March 23, 1998, CenTra and its
affiliates filed a formal notice of intent to appeal certain orders of the
Oklahoma Federal Court but have not yet stated specifically the claims or
issues they or any of them will appeal.
<PAGE>
PAGE
F-20
Because all shares of the Company's stock owned by CenTra and its
affiliates are held by the U.S. District Court for the District of Nebraska
("Nebraska Court") it is unclear when or if CenTra and its affiliates will be
able to comply with the Oklahoma Federal Court's order. The Company believes
that it is not required to pay the judgments until CenTra and its affiliates
can deliver the shares to the Company.
The ultimate actual amounts resulting from potential motions for the
award
of costs and attorney fees plus matters related to potential appeals by the
parties could result in amounts significantly different from the Company's
estimates, and could have a material adverse effect on the Company and could
negatively impact future earnings.
On April 28, 1997, the Company's Board of Directors appointed a Committee
of the Board (the "Committee") to deal with all matters arising from the
Oklahoma litigation. The Committee was delegated all authority of the Board
on
these issues. The members of the Committee are Messrs. Jacoby, Maestri and
Davis, all of whom are non-parties to the CenTra litigation. The Committee
has
retained independent counsel. The individual members of the Committee review
issues relating to litigation strategy, officer and director indemnification,
and claims made under the Company's director and officer liability insurance
policy on a regular basis in conjunction with a similar committee composed of
Chandler USA directors. The Committee conducts its meetings outside the
United
States, but participates in telephone briefings and discussions at least twice
monthly.
All implications of the Oklahoma Federal Court's ruling have not been
fully evaluated by the Company. These issues are being studied by the
Company's management and the Committee. In the event that the Company should
decide to appeal, it may be required to post a supersedeas bond or bonds to
suspend execution of any judgments against it. The Company believes that if
it
elects to pay the judgments, the shares owned by CenTra or its affiliates
which
are the subject of the judgment must be returned to the Company unless CenTra
appeals and takes appropriate action to supercede the judgments, or the
Nebraska Court does not release the shares.
The Company's management believes that adequate financial resources are
available to post a supersedeas bond or to pay the judgments. As a holding
company, the Company 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 payment of these judgments would reduce investment
earnings or increase operating expenses in future periods.
Chandler USA is the judgment creditor in connection with derivative claim
judgments against certain Chandler officers and directors. Chandler USA's
Special Litigation Committee is considering the course of action Chandler USA
should take with regard to collection of those judgments.
CENTRA LITIGATION -- NEBRASKA
ADMINISTRATIVE. NAICO, which is domiciled in Nebraska, is regulated by
the Nebraska Department of Insurance (the "Department"). The Department
requires a Form A application and prior approval by the Department from anyone
seeking to acquire control, directly or indirectly, of an insurance company
regulated by the Department. CenTra, Can-Am and their affiliates filed a Form
A application with the Department to which the Company and certain of its
affiliates objected. On October 28, 1992, the Department denied CenTra's Form
A application. The Department found that (i) the financial condition of the
CenTra Group might jeopardize the financial stability of NAICO or prejudice
the
interests of policyholders; (ii) the competence, experience and integrity of
the CenTra Group is such that it would not be in the best interests of
policyholders or NAICO or the public for the CenTra Group to control NAICO;
and
(iii) the acquisition is likely to be hazardous or prejudicial to the public.
The CenTra Group appealed the Department's order to the Lancaster County
District Court for the State of Nebraska ("District Court"). The District
Court affirmed the Department's order on September 21, 1993. On December 1,
1995 the Nebraska Supreme Court affirmed the Department and the District Court
decisions. On May 13, 1996 the U.S. Supreme Court denied the CenTra Group's
Petition for Writ of Certiorari, thereby declining to review the decision of
the Nebraska Supreme Court.
<PAGE>
PAGE
F-21
NEBRASKA COURT ACTION. On October 6, 1995 Agnes Anne Moroun, sister of
M.J. Moroun, purported to acquire 1,441,000 shares of the voting stock of the
Company (the "Shares") from Can-Am Investments, Ltd., an affiliate of three of
the Company's directors, M.J. Moroun, Norman E. Harned, and Ronald W. Lech.
In
response to that action, NAICO filed an action on October 11, 1995 in the
District Court seeking an order sequestering the Shares based upon alleged
violations of the Nebraska Holding Company Systems Act and orders of the
Nebraska Department of Insurance. NAICO also sought a temporary order
enjoining further transfers of the Shares and an order requiring the custodian
of the Shares, Dean Witter, to deliver them to the court. Agnes Anne Moroun,
M.J. Moroun, Norman E. Harned, and others removed the action to the Nebraska
Court on October 17, 1995. The Nebraska Department of Insurance intervened on
that same date requesting relief substantially similar to that requested by
NAICO. The Honorable Warren K. Urbom conducted a hearing on October 18, 1995
and on October 30, 1995 granted the relief requested by NAICO. On October 31,
1995 the order was amended and was extended to 700 shares held by Can-Am
Investments, Ltd. and was extended to include the CenTra Group's claim to
rights to acquire stock. Dean Witter was directed to cause share certificates
to be issued and delivered to the Clerk of the Nebraska Court. On November 8,
1995 the share certificates were issued listing Can-Am Investments, Ltd. as
the
shareholder of 1,441,700 shares pursuant to the order of the Nebraska Court.
On November 2, 1995, Agnes Anne Moroun and the other defendants filed
responsive pleadings and counterclaims against NAICO and the Director of
Insurance of the State of Nebraska ("Insurance Director"). The counterclaims
sought declaratory relief confirming the validity of the purported October 6,
1995 transfer of the Shares and that the Insurance Director and the courts of
the State of Nebraska are without authority to sequester the Shares. The
counterclaims also seek a judgment determining that NAICO's current management
controls the Company without the approval of the Insurance Director and
incidental relief. The Nebraska Court ruled in favor of NAICO on the
counterclaims.
On March 25, 1997 the Nebraska Court, pursuant to the Nebraska Insurance
Holding Company Systems Act, ordered CenTra and certain of its affiliates to
divest all Chandler shares owned by them, regardless of when purchased. The
CenTra defendants own or control 3,133,450 Chandler shares. All such shares
are currently in the possession of the Nebraska Court pursuant to the 1995 and
1997 orders of the Nebraska Court (including the shares subject to the
Oklahoma
Federal Court stock rescission judgments). CenTra's shares represent
approximately 45.1% of the outstanding stock (including the shares subject to
the Oklahoma Federal Court stock rescission judgments and the stock held by
subsidiary). The Nebraska Court directed NAICO, the CenTra defendants and the
Nebraska Insurance Department to submit proposals to the Nebraska Court by
April 21, 1997 for the "orderly divestiture and disposition of the stock". A
hearing would then be scheduled to consider the proposals.
CenTra has subsequently appealed the March 25, 1997 order of the Nebraska
Court to the United States Court of Appeals for the Eighth Circuit where the
appeal is now pending. Oral argument is currently scheduled for April 1998.
CenTra's appeal of this order has resulted in a delay of the deadlines for
submitting the proposals and no new submission date has been set at this time.
On October 7, 1997 the Honorable Warren K. Urbom, U.S. District Judge for the
Nebraska Court, ordered CenTra, M.J. Moroun and others to deliver into the
registry of the Nebraska Court by November 6, 1997 all shares of Chandler
stock
owned or controlled by them or their affiliates not previously tendered, to
await the outcome of the appeal of his divestiture order. CenTra requested a
stay of that order. The stay was denied by Judge Urbom and CenTra was again
ordered to deliver their shares to the Nebraska Court, this time by January
12,
1998. CenTra appealed that order to the U.S. Court of Appeals for the Eighth
Circuit, which affirmed Judge Urbom's order. On February 9, 1998 CenTra
deposited an additional 1,691,750 shares with the Nebraska Court. Because of
the uncertainty of the outcome of CenTra's appeal of the Nebraska Court's
orders, and until the final proposals are submitted and accepted, the Company
is unable to predict the effect of the divestiture order on the rights,
limitations or other regulation of ownership of the stock of any existing or
prospective holders of the Company's common stock, or the effect on the market
price of the Company's stock.
The impact of the March 10, 1998 ruling of the Oklahoma Federal Court
(See
CenTra Litigation - Oklahoma) upon the divestiture order is currently unclear.
On March 27, 1997 the Nebraska Court declined to exercise jurisdiction
over 550,329 shares of Chandler stock held as security by Chandler
subsidiaries
for debts owed by two former agents but in which CenTra claimed to have option
rights. The Nebraska Court's ruling cleared the way for the Company's
subsidiaries to begin the process of disposing of these shares to retire the
agents' debts to the subsidiaries. CenTra did not appeal this order. During
the second quarter of 1997, ownership of 380,471 shares was transferred to a
Chandler subsidiary as payment for one of the agent's debts. In December
1997,
114,146 shares were transferred to a Chandler subsidiary and the balance of
the
pledged shares were transferred to unaffiliated persons and entities. These
transactions had the effect of canceling the debts secured by the shares. The
shares are held as a reduction of shareholders' equity.
<PAGE>
PAGE
F-22
CENTRA LITIGATION - OTHER
On September 25, 1997, NAICO learned that several CenTra affiliates had
filed two lawsuits in state court in Macomb County, Michigan against NAICO,
NAICO Indemnity and certain NAICO officers asserting the same claims made and
tried in the Oklahoma lawsuit described above (See CenTra Litigation -
Oklahoma). Those claims were purportedly prosecuted by CenTra on its own
behalf and on behalf of its subsidiaries. The Oklahoma Federal Court entered
a
judgment against CenTra on these claims. The damages sought are unspecified
but the claims are based upon NAICO's cancellation of CenTra's insurance in
1992. NAICO and NAICO Indemnity contend that the Oklahoma Federal Court's
adjudication is conclusive as to all claims. The lawsuits were removed to the
U.S. District Court for the Eastern District of Michigan, Southern Division
("Michigan Federal Court"). NAICO and NAICO Indemnity have filed dispositive
motions which are currently under advisement. On February 28, 1998 the
Michigan Federal Court ordered the lawsuits transferred to the Oklahoma
Federal
Court.
During the first quarter of 1997 the Company concluded an arbitration
proceeding involving DuraRock and recorded approximately $315,000 in
litigation
and settlement expenses related to this matter. Since December 31, 1997, the
Company has also resolved various issues resulting in settlement of litigation
and arbitration proceedings among subsidiaries of the Company and CenTra
affiliates, and has recorded litigation and settlement expenses of
approximately $147,000 in 1997.
In the CenTra litigation, certain officers of the Company and the
Company's directors other than Messrs. M.J. Moroun, Harned, Lech and Maestri
were named as defendants. In accordance with its Articles of Association, the
Company has 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.
The Company has paid expenses totaling approximately $2.1 million as of
December 31, 1997. A portion of these expenses relate to claims which have
been dismissed or which were decided in favor of the officers and directors.
In addition, certain expenses may be recovered from the Company's directors
and
officers policy insurer. As a result of various events in 1995, the Company
recorded an $818,000 estimated recovery of costs from its directors and
officers policy 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, the Company recorded an additional estimated recovery of
$982,000. The Company received a payment for the 1995 claim during 1996 in
the
amount of $795,000. In connection with the Oklahoma Federal Court judgments,
the Company recorded an additional estimated recovery of $2.7 million from the
Company's directors and officers policy insurer. The Company is entitled to a
total of $5 million under the applicable insurance policy. Some amounts have
been previously paid without dispute and the Company is negotiating with the
insurer for payment of the policy balance. The Company could recover the
remaining policy limits or could compromise its claim, and could incur
significant costs in either case. The estimated insurance recovery is based
upon these variable factors. Except for the recovery of a portion of the
litigation costs from the Company's directors and officers policy insurer, no
provision has been made in the accompanying consolidated financial statements
related to the advancement of litigation expenses to certain defendants. The
Committee was delegated the authority of the Board to deal with all issues
arising from the Oklahoma litigation including the issue of officer and
director indemnification.
At the present time the Company is actively participating in court
proceedings, possible discovery actions and rights of appeal concerning these
various legal proceedings; therefore, the Company is unable to predict the
outcome of such litigation with certainty or the effect of such ongoing
litigation on future operations.
OTHER LITIGATION
The Company 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 and NAICO Indemnity cede
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 and NAICO Indemnity'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 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 surety bonds, workers
compensation and casualty reinsurance programs.
<PAGE>
PAGE
F-23
Under the 1997 workers compensation reinsurance program, the combined net
retention for NAICO and Chandler Barbados was $1,000,000 of loss per
occurrence. Effective February 1, 1998, the combined net retention was
reduced
to $500,000 of loss per occurrence. The combined net retention under the 1997
casualty reinsurance program was $500,000 of loss per occurrence. Effective
February 1, 1998, the combined net retention was reduced to $250,000 of loss
per occurrence. The combined net retention under the surety bond reinsurance
program is $500,000 per bond or per principal (e.g. contractor). NAICO
retains
30% of the first $500,000 of risk for each loss per location under its
property
reinsurance program. 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.
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 and July 1 of each
year. NAICO renewed all January 1 reinsurance programs. At the present time,
NAICO expects to renew the reinsurance programs on April 1 and July 1.
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, 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. In 1995, NAICO elected to commute the
unpaid losses and loss adjustment expenses related to reinsurance contracts
covering certain business written in 1993, 1994 and 1995 which resulted in an
increase in net premiums earned of $2,285,000. Beginning in 1996, NAICO
reviewed the historical results for reinsurance contracts with similar
commutation provisions and began accruing for such commutations where a
commutation election was considered likely, which resulted in an increase in
net premiums earned of $730,000 and $1,648,000 in 1996 and 1997, respectively.
Reinsurance contracts do not relieve an insurer from its obligation to
policyholders. Failure of reinsurers to honor their obligations could result
in losses to the Company; consequently, allowances are established for amounts
deemed uncollectible. NAICO charged $440,000, $2,078,000 and $527,000 to
policy acquisition costs during 1995, 1996 and 1997, respectively, for
estimated uncollectible reinsurance recoverables from certain unaffiliated
reinsurers.
The effect of reinsurance on premiums written and earned was as follows:
<TABLE>
<CAPTION>
1995 1996 1997
-------------------- --------------------
- --------------------
WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED
--------- --------- --------- --------- ---------
- ---------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Direct.........$ 95,520 $ 92,021 $103,801 $ 98,550 $123,014 $116,101
Assumed........ 3,248 2,614 4,142 4,664 74 608
Ceded.......... (14,128) (13,548) (14,228) (13,928) (26,222)
(22,030)
--------- --------- --------- --------- ---------
- ---------
Net premiums...$ 84,640 $ 81,087 $ 93,715 $ 89,286 $ 96,866 $ 94,679
========= ========= ========= ========= =========
=========
</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 $6.6 million, $4.2
million and $10.6 million for 1995, 1996 and 1997, respectively.
<PAGE>
PAGE
F-24
SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK
NAICO conducts a substantial part of 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. Receivables under installment plans do not exceed
the corresponding liability for unearned premiums. Total consolidated
premiums
receivable at December 31, 1997 were $28.1 million. Receivables for
deductibles, in most cases, are secured by cash deposits and letters of
credit.
At December 31, 1997, the Company maintained custody of such letters of credit
securing these and other transactions totaling approximately $9.2 million,
which is a reasonable estimate of their fair value. These letters of credit
are not reflected in the accompanying consolidated financial statements.
NAICO's largest unaffiliated independent insurance agent during 1995 was
responsible for producing $11.0 million of NAICO's direct written and assumed
premiums. There were no unaffiliated independent insurance agents that
produced 10% or more of NAICO's direct written and assumed premiums during
1996
or 1997.
NAICO's largest underwriting manager was responsible for underwriting
$11.5 million, $11.9 million and $12.3 million of NAICO's direct written and
assumed premiums for the California and Arizona portions of the nonstandard
private-passenger automobile program in 1995, 1996 and 1997, respectively.
Premiums receivable and currently due from this underwriting manager were
$596,000 and $612,000 at December 31, 1996 and 1997, respectively.
Approximately $3.0 million, or 12.9% of the Company's reinsurance
recoverables at December 31, 1997 are collateralized by premiums payable to
the
reinsurers, securities pledged in trust or letters of credit for the benefit
of
NAICO. The Company believes the above value of such collateral is a
reasonable
estimate of their fair value. NAICO's reinsurance contracts include
provisions
for offsets against premiums owed to the reinsurers.
The following table sets forth certain information related to NAICO and
NAICO Indemnity's five largest reinsurers (excluding Chandler Barbados) by net
reinsurance recoverables as of December 31, 1997.
<TABLE>
<CAPTION>
NET A.M.
REINSURANCE BEST CO.
NAME OF REINSURER RECOVERABLE (1) RATING
- --------------------------------- --------------- --------
(Dollars in thousands)
<S> <C> <C>
Jefferson Insurance
Company of New York.......... $ 4,523 A
National Union Fire Insurance
Company of Pittsburgh (2).... 3,930 A++
SCOR Reinsurance Company......... 3,831 A+
National American Insurance
Company of California........ 1,123 B++
Transamerica Occidental
Life Insurance Company....... 1,122 A+
---------------
Top five reinsurers.......... $ 14,529
===============
All reinsurers............... $ 23,607
===============
Percentage of total represented
by top five reinsurers....... 61.5%
- ---------------------------------
<FN>
(1) Includes losses and loss adjustment expenses paid and outstanding, unpaid
losses and loss adjustment expenses and unearned premium reserves
recoverable from reinsurers as of December 31, 1997.
(2) National Union Fire Insurance Company of Pittsburgh, Pennsylvania assumed
the reinsurance obligations of DuraRock Underwriters, Ltd. effective
March
31, 1993.
</TABLE>
OTHER
See Note 10 regarding contingencies relating to litigation matters.
Chandler USA entered into employment contracts with three executive
officers of the Company and an employee of one of the Company's subsidiaries
during 1988. Each employment agreement has an initial term of 10 years,
extended by one additional year for each year worked beyond the fifth year,
with final termination at age 70. The aggregate annual commitment for base
salaries under these agreements is approximately $974,000. Under certain
limited circumstances, such officers could receive base salaries subsequent to
an early termination of their employment subject to certain continued
obligations to Chandler USA. Effective May 1, 1997 one of these executive
officers, Benjamin T. Walkingstick, ceased to be employed by the Company, but
continues to serve as a consultant. On September 18, 1997 he entered into a
separate contract with L&W relating to insurance sales on a commission basis.
Commissions paid under this agreement during 1997 totaled $10,832.
<PAGE>
PAGE
F-25
Chandler USA entered into employment contracts with three employees of
Network in October 1995. Two of the contracts have been terminated and one
with an initial five year term remains in effect. The aggregate annual
commitment for base salary under this agreement is approximately $42,000.
NAICO is subject to a variety of assessments related to insurance
activities, including those by state guaranty funds and workers compensation
second-injury funds. The amounts and timing of such assessments are beyond
the
control of NAICO. NAICO provides for these charges on a current basis by
applying historical factors to premiums earned. Actual results may vary from
these values and adjustments therefrom are necessary to maintain an adequate
reserve for these assessments. The reserve for unpaid assessments was
approximately $1.4 million and $865,000 at December 31, 1996 and 1997,
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 $158,000 and $64,000 at December 31, 1996 and 1997,
respectively.
At December 31, 1997, the Company's subsidiaries were committed under
noncancellable operating leases for certain equipment and office space.
Rental
payments under these leases were $1.0 million in 1995 and $1.1 million in both
1996 and 1997. Future minimum lease payments are as follows:
<TABLE>
<CAPTION>
(In thousands)
<S> <C>
1998..............................$ 414
1999.............................. 151
2000.............................. 71
2001.............................. 56
2002.............................. 28
-------
$ 720
=======
</TABLE>
The future minimum lease payments shown above exclude amounts for a
previous equipment lease which was purchased and financed in February 1998.
See Note 4 for additional information.
NOTE 12. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
OPERATING TRANSACTIONS
The net effect of the Company's primary operating transactions with
related parties follow:
<TABLE>
<CAPTION>
DECEMBER 31,
- --------------------
BALANCE SHEETS 1996 1997
- ---------------------------------------------------------- --------
- --------
(In thousands)
<S> <C> <C>
Premiums receivable....................................... $ 174 $ 789
Unpaid losses and loss adjustment expenses,
net of reinsurance recoverable....................... 252 112
Accrued taxes and other payables.......................... 2,887
505
Premiums payable.......................................... 383 -
</TABLE>
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. 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. The Company
intends to seek payment of all amounts due and believes a reserve for
collection is not necessary at December 31, 1997. In addition, the Company's
subsidiaries reflected a payable to certain affiliates of CenTra in the amount
of $505,000 at December 31, 1997 in connection with the settlement of certain
litigation and arbitration proceedings.
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 agreed to assume the reinsurance obligations of
DuraRock effective March 31, 1993. Reinsurance recoverables from National
Union totaled approximately $32.1 million, $7.4 million and $3.9 million as of
December 31, 1995, 1996 and 1997, 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 the Company (see Notes 10 and 11).
<PAGE>
PAGE
F-26
OTHER
See Note 10 regarding advancement of litigation expenses to certain
officers and directors of the Company in the CenTra litigation.
See Note 11 regarding an insurance commission agreement in 1997.
A former director and officer and a current shareholder is Chairman of a
bank used by the Company's U.S. subsidiaries as their principal disbursement
bank. The Company's U.S. subsidiaries collectively maintain an average daily
balance of approximately $300,000. The balance maintained by each subsidiary
is fully insured by the Federal Deposit Insurance Corporation. The Company's
U.S. subsidiaries have also leased automobiles from this bank.
One of the Company's U.S. subsidiaries leases and has made certain
improvements to a rural property owned by certain directors and/or officers of
the Company. Under the lease, no cash rental is paid, but the subsidiary
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 the Company's U.S.
subsidiaries. The Company incurred approximately $108,000, $184,000 and
$159,000 in expenses associated with this property during 1995, 1996 and 1997,
respectively.
The Company believes that all transactions, including loans with
directors, officers, or shareholders of the Company, are and will continue to
be on terms no less favorable to the Company than could be obtained from
unaffiliated parties.
NOTE 13. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The Company's quarterly results of operations (unaudited) for 1996 and
1997 are as follows:
<TABLE>
<CAPTION>
BASIC
EARNINGS
TOTAL NET PER
COMMON
REVENUES INCOME SHARE
---------- ----------
- ----------
(Dollars in thousands
except per share amounts)
<S> <C> <C> <C>
1996
First quarter...........................$ 23,789 $ 663 $ 0.10
Second quarter.......................... 24,891 267 0.04
Third quarter........................... 26,351 537 0.08
Fourth quarter.......................... 25,214 (495)
(0.07)
1997
First quarter...........................$ 26,308 $ (10,327) $
(1.49)
Second quarter.......................... 28,151 538 0.08
Third quarter........................... 24,831 1,041 0.16
Fourth quarter.......................... 25,934 7,683
1.17
</TABLE>
The second quarter of 1996 included nontaxable income of $343,000 for a
settlement from a legal firm and a pretax charge for an arbitration award that
was $1.1 million less than expected. The third quarter of 1996 included a
credit to pretax income for the estimated recovery of certain litigation costs
of $982,000 and a pretax charge of $1.0 million related to amounts recoverable
from Midwest. The fourth quarter of 1996 included an additional pretax charge
of $534,000 related to amounts recoverable from Midwest. Legal expenses
related to the Midwest settlement and the CenTra litigation amounted to
$875,000 in the fourth quarter of 1996.
The first quarter of 1997 included a pretax charge of approximately $8.3
million ($8.5 million including provision for federal income tax) in
connection
with a jury verdict. In addition, the Company incurred litigation expenses of
approximately $1.8 million in the first quarter of 1997 due primarily to the
trial which began February 13, 1997. The Company also recorded approximately
$315,000 in litigation expenses related to the conclusion of an arbitration
proceeding in the first quarter of 1997.
In the fourth quarter of 1997, the Company recorded the rescission of
certain stock pursuant to an order issued on March 10, 1998 in the amount of
$6,882,500. This amount was originally expensed as a part of the $8.3 million
charge in the first quarter of 1997. Net litigation expenses were reduced by
this amount in the fourth quarter of 1997 as a result of the order.
Realized capital gains totaling approximately $728,000 before income
taxes
were recorded in the fourth quarter of 1997 as a result of NAICO shifting a
portion of its fixed maturities portfolio from taxable to tax exempt bonds and
NAICO's sale of Century Business Services, Inc. common stock.
* * * * * * *
<PAGE>
PAGE
F-27
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
Chandler Insurance Company, Ltd.:
We have audited the accompanying consolidated balance sheets of Chandler
Insurance Company, Ltd. and subsidiaries (the "Company") as of December 31,
1997 and 1996, and the related consolidated statements of operations,
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 1997 (all expressed in United States dollars). 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 the Company'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 auditing standards generally
accepted in the United States of America. Those standards require that we
plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Chandler Insurance Company, Ltd.
and subsidiaries at December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period
ended
December 31, 1997 in conformity with accounting principles generally accepted
in the United States of America. Also, in our opinion, such financial
statement schedules, when considered in relation to the basic consolidated
financial statements taken as a whole, present fairly, in all material
respects, the information set forth therein.
As discussed in Note 10 to the consolidated financial statements, various
legal
proceedings included, among others: (a) on March 10, 1998 a court entered
orders relating to judgments against the Company, and certain officers and/or
directors regarding various claims and violations of securities laws. The
parties to the litigation may appeal any or all of the orders of the court,
and
file motions for costs and fees related to the litigation; and (b) a
shareholder, who is also a director of the Company, and certain affiliates
with
ownership or control of Company common shares have been ordered by a
regulatory
authority and a court to divest of all such common shares. Appeals to the
court by such shareholders are currently pending.
/s/ Deloitte & Touche
DELOITTE & TOUCHE
Grand Cayman, Cayman Islands
March 23, 1998
<PAGE>
PAGE
F-28
SCHEDULE
I
CHANDLER INSURANCE COMPANY, LTD. AND SUBSIDIARIES
SUMMARY OF INVESTMENTS OTHER
THAN INVESTMENTS IN RELATED PARTIES
AS OF DECEMBER 31, 1997
(Dollars in thousands)
<TABLE>
<CAPTION>
AMOUNT AT
WHICH SHOWN
IN THE
FAIR BALANCE
TYPE OF INVESTMENT
COST VALUE SHEET
- -----------------------------------------------------------------
- ---------- ---------- -----------
<S>
<C> <C> <C>
FIXED MATURITIES AVAILABLE FOR SALE:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies........................ $
41,208 $ 41,390 $ 41,390
Debt securities issued by foreign governments....................
1,516 1,503 1,503
Obligations of states and political subdivisions.................
20,365 20,524 20,524
Corporate obligations............................................
35,836 35,731 35,731
Public utilities.................................................
9,048 9,092 9,092
Mortgage-backed securities.......................................
3,449 3,478 3,478
- ---------- ---------- -----------
$
111,422 $ 111,718 $ 111,718
- ---------- ---------- -----------
FIXED MATURITIES HELD TO MATURITY:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies........................ $
1,222 $ 1,330 $ 1,222
- ---------- ---------- -----------
EQUITY SECURITIES AVAILABLE FOR SALE:
Corporate stock.................................................. $
- - $ 124 $ 124
- ---------- ---------- -----------
Total investments...................................................$
112,644 $ 113,172 $ 113,064
========== ========== ===========
</TABLE>
<PAGE>
PAGE
F-29
SCHEDULE
II
CHANDLER INSURANCE COMPANY, LTD. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CHANDLER INSURANCE COMPANY, LTD.
(PARENT COMPANY ONLY)
BALANCE SHEETS
(Dollars in thousands)
<TABLE>
<CAPTION>
DECEMBER 31,
- -----------------------
1996 1997
----------
- ----------
<S> <C> <C>
ASSETS
Cash and cash equivalents...............................$ 16 $ 16
Investment in subsidiaries, net......................... 72,531 74,937
----------
- ----------
Total assets............................................$ 72,547 $ 74,953
==========
==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Litigation liabilities.............................$ - $ 16,618
----------
- ----------
Total liabilities....................................... - 16,618
----------
- ----------
Shareholders' equity
Common stock, $1.67 par value, 10,000,000
shares authorized; 6,941,708 shares issued...... 11,593 11,593
Paid-in surplus.................................... 34,942 34,942
Capital redemption reserve......................... 947 947
Retained earnings.................................. 25,951 24,886
Unrealized gain (loss) on investments
held by subsidiaries and available
for sale, net of tax............................ (886) 253
Less: Stock held by subsidiary, at cost
(494,617 shares)................................ -
(2,487)
Less: Stock rescinded through litigation
(1,660,125 shares).............................. -
(11,799)
----------
- ----------
Total shareholders' equity.............................. 72,547 58,335
----------
- ----------
Total liabilities and shareholders' equity..............$ 72,547 $ 74,953
==========
==========
</TABLE>
<PAGE>
PAGE
F-30
SCHEDULE
II
CHANDLER INSURANCE COMPANY, LTD. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CHANDLER INSURANCE COMPANY, LTD.
(PARENT COMPANY ONLY)
STATEMENTS OF OPERATIONS
(Dollars in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- ------------------------------------
1995 1996 1997
---------- ----------
- ----------
<S> <C> <C> <C>
Net investment income......................$ 2 $ - $ -
Litigation expenses, net................... - - 4,819
---------- ----------
- ----------
Income (loss) before equity in net
income (loss) of subsidiaries........... 2 -
(4,819)
Equity in net income (loss)
of subsidiaries......................... 3,776 972 3,754
---------- ----------
- ----------
Net income (loss)..........................$ 3,778 $ 972 $
(1,065)
========== ==========
==========
</TABLE>
<PAGE>
PAGE
F-31
SCHEDULE
II
CHANDLER INSURANCE COMPANY, LTD. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CHANDLER INSURANCE COMPANY, LTD.
(PARENT COMPANY ONLY)
STATEMENT OF CASH FLOWS
(Dollars in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- ------------------------------------
1995 1996 1997
---------- ----------
- ----------
<S> <C> <C> <C>
Operating activities:
Net income (loss).......................$ 3,778 $ 972 $
(1,065)
Adjustments to reconcile net income
(loss) to cash provided
by operations:
Net income of subsidiaries not
distributed to parent............. (3,776) (972)
(3,754)
Net change in non-cash balances
relating to operations:
Litigation liabilities............ - - 4,819
---------- ----------
- ----------
Cash provided by operations.......... 2 - -
---------- ----------
- ----------
Change in cash and cash equivalents
during the year......................... 2 - -
Cash and cash equivalents at
beginning of year....................... 14 16 16
---------- ----------
- ----------
Cash and cash equivalents at end of year...$ 16 $ 16 $ 16
========== ==========
==========
</TABLE>
<PAGE>
PAGE
F-32
SCHEDULE
III
CHANDLER INSURANCE COMPANY, LTD. AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
(Dollars in thousands)
<TABLE>
<CAPTION>
FUTURE
POLICY
BENEFITS, OTHER
DEFERRED
LOSSES, POLICY
POLICY
CLAIMS CLAIMS AND
ACQUISITION AND
LOSS UNEARNED BENEFITS PREMIUM
COSTS
EXPENSES PREMIUMS PAYABLE REVENUE
------------
- ------------ ------------ ------------ ------------
<S> <C>
<C> <C> <C> <C>
Year ended December 31, 1995
Property-casualty............................$ 3,800 $
128,794 $ 31,280 $ 4,484 $ 81,087
============
============ ============ ============ ============
Year ended December 31, 1996
Property-casualty............................$ 4,993 $
79,639 $ 36,009 $ 4,016 $ 89,286
============
============ ============ ============ ============
Year ended December 31, 1997
Property-casualty............................$ 5,312 $
74,929 $ 42,388 $ 4,830 $ 94,679
============
============ ============ ============ ============
<CAPTION>
AMORTIZATION NET
CLAIMS, OF DEFERRED PREMIUMS
NET LOSSES
AND POLICY OTHER WRITTEN
INVESTMENT
SETTLEMENT ACQUISITION OPERATING AND
INCOME
EXPENSES COSTS EXPENSES ASSUMED
------------
- ------------ ------------ ------------ ------------
<S> <C>
<C> <C> <C> <C>
Year ended December 31, 1995
Property-casualty............................$ 8,053 $
50,543 $ 23,995 $ 13,107 $ 84,640
============
============ ============ ============ ============
Year ended December 31, 1996
Property-casualty............................$ 7,339 $
53,391 $ 32,123 $ 14,076 $ 93,715
============
============ ============ ============ ============
Year ended December 31, 1997
Property-casualty............................$ 8,017 $
57,512 $ 28,145 $ 18,351 $ 96,866
============
============ ============ ============ ============
</TABLE>
<PAGE>
PAGE
F-33
SCHEDULE
IV
CHANDLER INSURANCE COMPANY, LTD. 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, 1995
Property-casualty......$ 95,520 $ 14,128 $ 3,248 $ 84,640
3.84%
========= ========= ========= =========
==========
Year ended
December 31, 1996
Property-casualty......$ 103,801 $ 14,228 $ 4,142 $ 93,715
4.42%
========= ========= ========= =========
==========
Year ended
December 31, 1997
Property-casualty......$ 123,014 $ 26,222 $ 74 $ 96,866
0.08%
========= ========= ========= =========
==========
</TABLE>
<PAGE>
PAGE
F-34
SCHEDULE
V
CHANDLER INSURANCE COMPANY, LTD. 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:
1995.....................$ 74 $ 124 $ (21) $
177
========= ============== ==========
==========
1996.....................$ 177 $ 1,768 $ (1,768) $
177
========= ============== ==========
==========
1997.....................$ 177 $ 52 $ (114) $
115
========= ============== ==========
==========
Allowance for non-collection
of reinsurance recoverables
on paid and unpaid losses:
1995.....................$ 272 $ 440 $ (98) $
614
========= ============== ==========
==========
1996.....................$ 614 $ 2,078 $ (2,201) $
491
========= ============== ==========
==========
1997.....................$ 491 $ 527 $ (353) $
665
========= ============== ==========
==========
</TABLE>
<PAGE>
PAGE
F-35
SCHEDULE
VI
CHANDLER INSURANCE COMPANY, LTD. AND SUBSIDIARIES
SUPPLEMENTAL INFORMATION
(FOR PROPERTY-CASUALTY INSURANCE UNDERWRITERS)
(Dollars in thousands)
<TABLE>
<CAPTION>
DISCOUNT PAID
LOSSES
DEDUCTED AND LOSS
FROM
ADJUSTMENT
RESERVES EXPENSES
-----------
- -----------
<S> <C> <C>
Year ended December 31, 1995
Property-casualty...............................$ - $
67,049
===========
===========
Year ended December 31, 1996
Property-casualty...............................$ - $
70,349
===========
===========
Year ended December 31, 1997
Property-casualty...............................$ - $
59,052
===========
===========
</TABLE>
<PAGE>
PAGE
F-36
EXHIBIT
22.1
CHANDLER INSURANCE COMPANY, LTD. AND SUBSIDIARIES
LIST OF ALL SUBSIDIARIES
1. Chandler Insurance (Barbados), Ltd., a Barbados company ("Chandler
Barbados") that is a wholly owned subsidiary of the Company.
2. Chandler (U.S.A.), Inc., an Oklahoma corporation ("Chandler USA") that is
a wholly owned subsidiary of Chandler Barbados.
3. LaGere & Walkingstick Insurance Agency, Inc., an Oklahoma corporation
("L&W") that is a wholly owned subsidiary of Chandler USA.
4. National American Insurance Company, a Nebraska corporation ("NAICO")
that
is a wholly owned subsidiary of Chandler USA.
5. Network Administrators, Inc., a Texas corporation ("Network") that is a
wholly owned subsidiary of Chandler USA.
6. NAICO Indemnity (Cayman), Ltd., a Cayman Islands company ("NAICO
Indemnity") that is a wholly owned subsidiary of the Company.
7. Chandler Insurance Management, Ltd., a Cayman Islands company ("CIM")
that
is a wholly owned subsidiary of the Company.
8. Chandler Insurance Management (Barbados), Ltd., a Barbados company ("CIM
Barbados") that is a wholly owned subsidiary of the Company.
9. Windsor Acquisition Corporation, an Oklahoma corporation ("Windsor") that
is a wholly owned subsidiary of Chandler Barbados.
<PAGE>
PAGE
F-37
EXHIBIT
23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Post-Effective Amendment No. 3
to Form S-2 on Form S-8 Registration Statement No. 33-28436 of Chandler
Insurance Company, Ltd. of our report dated March 23, 1998 (which expresses an
unqualified opinion and includes an explanatory paragraph relating to
litigation) appearing in the Annual Report on Form 10-K of Chandler Insurance
Company, Ltd. for the year ended December 31, 1997.
/s/ Deloitte & Touche
DELOITTE & TOUCHE
Grand Cayman, Cayman Islands
March 27, 1998
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CHANDLER
INSURANCE COMPANY, LTD.'S DECEMBER 31, 1997 FORM 10-K AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<DEBT-HELD-FOR-SALE> 111,718
<DEBT-CARRYING-VALUE> 1,222
<DEBT-MARKET-VALUE> 1,330
<EQUITIES> 124
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 113,064
<CASH> 11,999
<RECOVER-REINSURE> 3,069
<DEFERRED-ACQUISITION> 5,312
<TOTAL-ASSETS> 210,790
<POLICY-LOSSES> 74,929
<UNEARNED-PREMIUMS> 42,388
<POLICY-OTHER> 4,830
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 2,796
0
0
<COMMON> 11,593
<OTHER-SE> 46,742
<TOTAL-LIABILITY-AND-EQUITY> 210,790
94,679
<INVESTMENT-INCOME> 8,017
<INVESTMENT-GAINS> 764
<OTHER-INCOME> 2,528
<BENEFITS> 57,512
<UNDERWRITING-AMORTIZATION> 28,145
<UNDERWRITING-OTHER> 18,351
<INCOME-PRETAX> 1,216
<INCOME-TAX> 2,281
<INCOME-CONTINUING> (1,065)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,065)
<EPS-PRIMARY> (0.16)
<EPS-DILUTED> (0.16)
<RESERVE-OPEN> 65,207
<PROVISION-CURRENT> 53,704
<PROVISION-PRIOR> 3,808
<PAYMENTS-CURRENT> 22,214
<PAYMENTS-PRIOR> 36,838
<RESERVE-CLOSE> 64,053
<CUMULATIVE-DEFICIENCY> 3,808
</TABLE>
