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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
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, 1999 was $21,742,568 (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, 1999 was 6,941,708, which includes 544,475 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1,660,125 common shares which were rescinded through litigation and are held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; (vii) the ability of
the Company and its third party providers, agents and reinsurers to adequately
address year 2000 issues; and (viii) 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 insurance coverage for businesses
in various industries and political subdivisions, surety bonds for small
contractors and group accident and health insurance. 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)." NAICO received an "A (Strong)" financial strength
rating by Standard & Poor's during 1998. Standard & Poor's financial strength
ratings range from the highest rating of "AAA (Extremely Strong)" to the lowest
rating of "R (Regulatory Action)." These ratings are independent opinions of a
company's financial strength, operating performance and ability to meet its
obligations to policyholders.
Chandler Insurance (Barbados), Ltd. ("CIB"), 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 CIB. Such reinsurance
arrangements are governed by reinsurance contracts between NAICO and each of
its reinsurers and CIB 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 and casualty, individual and group life,
medical and disability income coverages. L&W also acts as a surplus lines
broker specializing in risk management and brokering insurance for commercial
enterprises.
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 Cayman Islands Monetary Authority (the
"Monetary Authority"). CIB is subject to similar Barbados regulations. See
"Regulation." Although CIB 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."
INSURANCE PROGRAMS
STANDARD PROPERTY AND CASUALTY PROGRAM
NAICO offers workers compensation, automobile liability and physical
damage, general and umbrella liability and property coverages under its
standard property and casualty program. In marketing these products, NAICO
targets companies in the construction, retail, manufacturing, wholesale,
service, oil and gas, and retail industries. NAICO writes this business
principally in Oklahoma and Texas.
POLITICAL SUBDIVISIONS PROGRAM
Under the political subdivisions program, NAICO writes insurance policies
for school districts, counties and municipalities. As of January 31, 1999,
NAICO insured 494 school districts in Oklahoma. In 1996, NAICO began
marketing its political subdivisions program in Texas and as of January 31,
1999, insured 136 school districts in Texas. The coverages offered include
workers compensation, automobile liability, automobile physical damage,
general liability, property and school board legal liability.
<PAGE>
PAGE 2
In 1991, NAICO began writing property and casualty insurance for
municipalities and counties in Oklahoma. NAICO has also begun writing property
and casualty insurance for municipalities and counties in Texas and Missouri.
The coverages offered include workers compensation, automobile and general
liability, automobile physical damage, property and public officials liability
insurance. As of January 31, 1999, NAICO insured 282 municipalities and
counties in Oklahoma, Texas and Missouri.
SURETY BOND PROGRAM
NAICO writes surety bonds, commonly referred to as contract performance
bonds, to secure the performance of contractors and suppliers on construction
projects. Individual bonds generally do not exceed $5 million, and an
individual contractor generally does not have "work in progress" for both
bonded and unbonded jobs in excess of $10 million. A substantial portion of
this business is written in Oklahoma, Texas, New Mexico and California. NAICO
also writes bail bonds, which guarantee that the principal will discharge
obligations set by the court, as well as other types of miscellaneous bonds.
GROUP ACCIDENT AND HEALTH PROGRAM
In January 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. During 1997, NAICO began offering fully insured
group accident and health coverage on a limited basis. NAICO generally writes
this business in Oklahoma and Texas. NAICO is currently evaluating this
program and may modify or discontinue certain portions of this program during
1999.
NONSTANDARD PRIVATE-PASSENGER AUTOMOBILE PROGRAM
In late 1993, NAICO began writing nonstandard private-passenger automobile
liability and automobile physical damage coverage in Oklahoma. During 1994,
NAICO began writing a similar program in California and Arizona. The Oklahoma
and Arizona portions of the program were discontinued in 1997. Effective July
1, 1997, NAICO entered into a 100% quota share reinsurance agreement to fully
reinsure the risk in the California portion of the program. NAICO discontinued
the California program during 1998.
LINES OF INSURANCE
The following table shows net premiums earned as a percentage of total
net premiums earned by each line of insurance written by the Company during
the period indicated. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS."
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1994 1995 1996 1997 1998
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Workers compensation.................. 48% 46% 48% 47% 28%
Automobile liability.................. 17 19 20 16 20
Other liability....................... 6 8 10 13 20
Surety................................ 24 18 11 12 14
Automobile physical damage............ 3 7 8 6 7
Accident and health................... 1 - - 3 7
Property.............................. 1 2 2 2 3
Inland marine......................... - - 1 1 1
------ ------ ------ ------ ------
Total............................ 100% 100% 100% 100% 100%
====== ====== ====== ====== ======
</TABLE>
AGENCY AND BROKERAGE
L&W is appointed by insurers to solicit applications for insurance
policies, primarily in Oklahoma. L&W represents various personal and
commercial lines insurance companies in marketing property and casualty
insurance. L&W also markets individual and group life, medical and
disability income coverage. Major target classes of business include
political subdivisions, healthcare facilities, transportation companies,
manufacturers, contractors, energy businesses, retailers, wholesalers and
service organizations. L&W places a large portion of its property and
casualty business with NAICO. It also acts as a surplus lines broker
specializing in risk management and brokering insurance for commercial
enterprises. L&W places direct agency business as well as business from
other agents with specialty insurance companies.
L&W acts as a broker for NAICO, accepting applications for insurance
and surety bonds from independent agents who, in many instances, are not
agents appointed directly by NAICO. L&W also acts as an underwriter for a
significant portion of NAICO's surety bond program.
UNDERWRITING AND CLAIMS
Independent insurance agents submit applications for insurance coverage
for prospective customers to NAICO. NAICO reviews a prospective risk in
accordance with its specific underwriting guidelines. If the risk is
approved and coverage is accepted by the insured, NAICO issues an insurance
policy.
NAICO has maintained a continuous contractual relationship with an
underwriting manager for its bail bond program. During 1996, 1997 and 1998,
the gross written premiums in this program were $2.7 million, $2.6 million
and $2.8 million, respectively. This underwriting manager operates through
a network of bail bond agents who submit applications to the underwriting
manager. If the application meets the specific guidelines set by the
underwriting manager, a bail bond is issued. This underwriting manager is
an independent contractor and is responsible for collection of all premiums
and payment of all commissions to bail bond agents. Additionally, it is
responsible for all claims and recoveries and is required to maintain
collateral security for each bond.
<PAGE>
PAGE 3
The underwriting manager responsible for the California and Arizona
portions of the nonstandard private-passenger automobile program produced
$11.9 million, $12.3 million and $4.0 million of NAICO's direct written and
assumed premiums in 1996, 1997 and 1998, respectively. The program
underwritten by this underwriting manager was discontinued in 1998.
NAICO's claim department reviews and administers all claims. When a
claim is received, it is reviewed and assigned to an in-house claim adjuster
based on the type and geographic location of the claim, its severity and
its class of business. NAICO's claim department is responsible for
reviewing each claim, obtaining necessary documentation and establishing
loss and loss adjustment expense reserves. NAICO's in-house claims staff
handles and supervises the claims, coordinates with outside legal counsel
and independent claims adjusters if necessary, and processes the claims to
conclusion.
REINSURANCE
In the ordinary course of business, NAICO cedes insurance risks and a
portion of the insurance premiums to its reinsurers under various
reinsurance contracts that cover individual risks (facultative reinsurance)
or entire classes of business (treaty reinsurance). Reinsurance provides
greater diversification of insurance risk associated with business written
and also reduces NAICO's exposure from high policy limits or from catastrophic
events and hazards of an unusual nature. Amounts recoverable from reinsurers
are estimated in a manner consistent with the claim liability associated with
the reinsured policies. In formulating its reinsurance programs, NAICO
considers numerous factors, including the financial stability of the reinsurer,
the reinsurer's ability to provide sufficient collateral (if required),
reinsurance coverage offered and price.
Treaty reinsurance may be ceded under treaties on both a pro rata or
proportional basis (where the reinsurer shares proportionately in premiums and
losses) and an excess of loss basis (where only losses above a specific amount
are reinsured). The availability, costs and limits of reinsurance purchased
varies from year to year based upon prevailing market conditions, reinsurers'
underwriting results and NAICO's desired risk retention levels. A majority
of NAICO's reinsurance programs renew on January 1, April 1 or July 1 of each
year. NAICO renewed all January 1, 1999 reinsurance programs. At the present
time, NAICO expects to renew the reinsurance programs that renew on April 1 or
July 1, 1999 as applicable.
NAICO has structured separate reinsurance programs for construction
surety bonds, property (including inland marine), workers compensation,
casualty (including automobile liability and physical damage, general
liability, umbrella liability, and related professional liability) and group
accident and health. CIB reinsures NAICO for a portion of the risk on
NAICO's construction surety bonds, workers compensation and casualty
reinsurance programs.
Under the 1997 workers compensation reinsurance program, the combined net
retention for NAICO and CIB was $1,000,000 of loss per occurrence. During
1998, the combined net retention was reduced to 70% of the first $10,000 of
loss per occurrence.
The combined net retention under the 1997 casualty reinsurance program
was $500,000 of loss per occurrence. During 1998, the combined net retention
was reduced to $250,000 of loss per occurrence.
Under the 1997 construction surety bond reinsurance program, the combined
net retention was $500,000 per bond or per principal (e.g., contractor).
During 1998, the combined net retention was reduced to $250,000 per bond or
per principal.
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. NAICO retains the
first $100,000 of risk for each insured person for fully insured cases under
its group accident and health program.
NAICO purchases catastrophe protection 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.
The following table sets forth certain information related to NAICO's
five largest reinsurers (excluding CIB) determined on the basis of net
reinsurance recoverables as of December 31, 1998.
<TABLE>
<CAPTION>
NET CEDED A.M.
REINSURANCE REINSURANCE BEST CO.
NAME OF REINSURER RECOVERABLE (1) PREMIUMS RATING
- ----------------------------------- --------------- ----------- ----------
(In thousands)
<S> <C> <C> <C>
First Excess and Reinsurance Corporation.. $ 15,613 $ 21,420 A
Reliance Insurance Company................ 13,948 19,111 A-
SCOR Reinsurance Company.................. 5,196 8,061 A+
Jefferson Insurance Company of New York... 2,345 3,638 A
Swiss Reinsurance America Corporation..... 1,900 2,889 A+
--------------- -----------
Top five reinsurers.................... $ 39,002 $ 55,119
=============== ===========
All reinsurers......................... $ 54,178 $ 68,793
=============== ===========
Percentage of total represented by
top five reinsurers.................... 72.0% 80.1%
- --------------------------------------------
<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, 1998.
</TABLE>
<PAGE>
PAGE 4
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 1996, 1997 and 1998, NAICO charged to
policy acquisition costs $2.1 million, $527,000 and $50,000, respectively,
in uncollectible reinsurance recoverables from unaffiliated reinsurers. See
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS."
LOSS AND UNDERWRITING EXPENSE RATIOS
The combined loss and underwriting expense ratio ("Combined Ratio") is
the traditional measure of underwriting experience for property and casualty
insurance companies. It is the sum of the ratios of (i) incurred losses and
loss adjustment expenses to net premiums earned ("loss ratio") and (ii)
underwriting expenses to net premiums written and assumed ("underwriting
expense ratio").
The following table shows the underwriting experience of 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 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,
------------------------------------------------
1994 1995 1996 1997 1998
-------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Workers compensation:
Net premiums earned.........$39,183 $37,066 $42,813 $44,954 $19,651
Loss ratio.................. 65% 62% 53% 66% 71%
Automobile liability:
Net premiums earned.........$13,551 $15,498 $17,581 $15,593 $14,139
Loss ratio.................. 108% 74% 98% 89% 75%
Other liability:
Net premiums earned.........$ 4,759 $ 6,579 $ 8,656 $12,209 $14,045
Loss ratio.................. 63% 43% 60% 49% 70%
Surety:
Net premiums earned.........$19,950 $14,237 $10,123 $11,256 $10,101
Loss ratio.................. 51% 56% (1)% 9% 16%
Automobile physical damage:
Net premiums earned.........$ 2,342 $ 5,881 $ 6,788 $ 5,726 $ 4,702
Loss ratio.................. 64% 68% 74% 60% 85%
Accident and health:
Net premiums earned.........$ 754 $ 230 $ 564 $ 2,529 $ 4,646
Loss ratio.................. 70% (49)% 56% 43% 91%
Property:
Net premiums earned.........$ 982 $ 1,369 $ 1,467 $ 1,912 $ 2,332
Loss ratio.................. 80% 73% 114% 74% 136%
Inland marine:
Net premiums earned.........$ 76 $ 227 $ 1,294 $ 500 $ 448
Loss ratio.................. (154)% 84% 115% 195% 123%
Total:
Net premiums earned.........$81,597 $81,087 $89,286 $94,679 $70,064
Loss ratio.................. 69% 62% 60% 61% 68%
Underwriting expense
ratio (1)............... 34% 39% 46% 39% 37%
-------- -------- -------- -------- --------
Combined Ratio (1).......... 103% 101% 106% 100% 105%
======== ======== ======== ======== ========
- --------------------------------
<FN>
(1) Litigation expenses are not considered underwriting expenses; therefore,
such costs have been excluded from these ratios. The 1996 underwriting expense
ratio was increased by four percentage points by a reinsurance arbitration
adjustment and the termination of relations with the Company's former surety
bond underwriting manager.
</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 incurred but not
reported losses under their previously issued insurance policies and/or
reinsurance contracts. In estimating reserves, insurance companies use
various standardized methods based on historical experience and payment and
reporting patterns for the type of risk involved. The application of these
methods involves subjective determinations by the personnel of the insurance
company. Inherent in the estimates of the ultimate liability for unpaid
claims are expected trends in claim severity, claim frequency and other
factors that may vary as claims are settled. The amount of and uncertainty
in the estimates are affected by such factors as the amount of historical
claims experience relative to the development period for the type of risk,
knowledge of the actual facts and circumstances and the amount of insurance
risk retained. The ultimate cost of insurance claims can be adversely
affected by increased costs, such as medical expenses, repair expenses, costs
of providing legal defense for policyholders, increased jury awards and court
decisions and legislation that 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.
<PAGE>
PAGE 5
NAICO periodically reviews the reserve estimates relating to insurance
business written or assumed by NAICO and CIB 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 $3.8 million and
$5.3 million at December 31, 1997 and 1998, respectively.
CIB 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 and the Supervisor of
Insurance of Barbados. NAICO's statutory-based reserves (reserves calculated
in accordance with an insurer's domiciliary state insurance regulatory
authorities) do not differ from its U.S. GAAP reserves. Neither NAICO nor CIB
discounts its reserves for unpaid losses or loss adjustment expenses.
NAICO participates in various pools covering workers compensation risks
for insureds who were unable to purchase this coverage from an insurance
company on a voluntary basis. In addition, NAICO receives direct assignments
to write workers compensation for such insureds in lieu of participating in
the pools. The consolidated financial statements reflect the reserves for
unpaid losses and loss adjustment expenses and net premiums earned from its
participation in the pools and from these direct assignments.
There may be significant reporting lags between the occurrence of the
insured loss and the time it is actually reported to the insurer. The
inherent uncertainties in estimating insurance reserves are generally
greater for casualty coverages, such as workers compensation, general and
automobile liability, than for property coverages primarily due to the longer
period of time that typically elapses before a definitive determination of
ultimate loss can be made, which is also affected by changing theories of
legal liability and changing political climates.
There are significant additional uncertainties in estimating the amount
of reserves required for environmental, asbestos-related and other latent
exposure claims, including a lack of historical data, long reporting delays
and complex unresolved legal issues regarding policy coverage and the extent
and timing of any such contractual liability. Courts have reached different
and frequently inconsistent conclusions as to when the loss occurred, what
claims are covered, under what circumstances the insurer has an obligation to
defend, how policy limits are determined and how policy exclusions are applied
and interpreted.
The loss settlement period on insurance claims for property damage is
relatively short. The more severe losses for bodily injury and workers
compensation claims have a much longer loss settlement period and may be paid
out over several years. It is often necessary to adjust estimates of
liability on a loss either upward or downward 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, 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,
-----------------------------------------------------------
1994 1995 1996 1997 1998
---------- ---------- ---------- ---------- ----------
(In thousands)
<S> <C> <C> <C> <C> <C>
Net balance before provision for
uncollectible reinsurance at
beginning of year............. $ 110,253 $ 97,894 $ 81,388 $ 64,430 $ 62,890
---------- ---------- ---------- ---------- ----------
Net losses and loss adjustment
expenses incurred related to:
Current year............... 54,753 50,975 53,314 53,704 42,724
Prior years................ 1,119 (432) 77 3,808 5,155
---------- ---------- ---------- ---------- ----------
Total................... 55,872 50,543 53,391 57,512 47,879
---------- ---------- ---------- ---------- ----------
Net paid losses and loss adjustment
expenses related to:
Current year............... (18,433) (21,106) (23,836) (22,214) (23,152)
Prior years................ (49,798) (45,943) (46,513) (36,838) (36,423)
---------- ---------- ---------- ---------- ----------
Total................... (68,231) (67,049) (70,349) (59,052) (59,575)
---------- ---------- ---------- ---------- ----------
Net balance before provision for
uncollectible reinsurance at
end of year................... 97,894 81,388 64,430 62,890 51,194
Adjustments to reinsurance
recoverables on unpaid
losses for uncollectible
reinsurance.................. 698 629 777 1,163 745
---------- ---------- ---------- ---------- ----------
Net balance at end of year....... $ 98,592 $ 82,017 $ 65,207 $ 64,053 $ 51,939
========== ========== ========== ========== ==========
</TABLE>
<PAGE>
PAGE 6
The following table represents the development of net balance sheet
reserves for 1989 through 1998. The top line of the table shows the net
reserves at the balance sheet date for each of the indicated years. This
represents the estimated amounts of claims and claim expenses, net of
reinsurance deductions, arising in the current and all prior years that are
unpaid at the balance sheet date, including the net reserve for incurred but
not reported claims. The upper portion of the table shows the cumulative net
amounts paid as of successive years with respect to that reserve liability.
The estimate for unpaid losses and loss adjustment expenses changes as more
information becomes known about the frequency and severity of claims for
individual years. The next portion of the table shows the revised estimated
amount of the previously recorded net reserve based on experience as of the
end of each succeeding year. The heading "net cumulative deficiency"
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 seven 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 1992 for
claims that occurred in 1989 will be included in the cumulative deficiency
amount for years 1989, 1990, 1991 and 1992. 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,
-------------------------------------------------------------------------------------------------------------
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net reserve for
unpaid losses and
loss adjustment
expenses (1).......$ 62,738 $ 125,348 $ 144,430 $ 119,963 $ 99,685 $ 98,592 $ 82,017 $ 65,207 $ 64,053 $ 51,939
Net paid (cumulative)
as of
One year later..... 35,715 67,898 78,323 61,417 49,798 45,943 46,513 36,837 36,423
Two years later.... 71,176 114,793 120,319 94,047 73,225 72,718 65,754 52,078
Three years later.. 89,987 136,134 144,900 109,885 90,909 85,006 72,206
Four years later... 98,556 150,709 155,816 122,757 98,193 88,986
Five years later... 104,545 155,589 165,357 127,725 100,117
Six years later.... 106,418 159,396 168,509 129,070
Seven years later.. 108,216 160,358 169,494
Eight years later.. 108,542 160,771
Nine years later... 108,553
Net liability
re-estimated
as of (1)
One year later..... 84,534 144,798 160,938 125,202 100,804 98,160 82,094 69,015 69,208
Two years later.... 100,219 156,986 163,100 127,557 101,467 96,279 84,023 71,183
Three years later.. 106,624 157,264 166,807 129,449 101,539 98,549 84,277
Four years later... 107,097 160,961 167,935 129,958 102,626 98,750
Five years later... 109,262 160,481 169,143 131,109 103,275
Six years later.... 108,652 160,736 170,077 131,522
Seven years later.. 108,635 161,117 170,403
Eight years later.. 108,645 161,395
Nine years later... 108,730
Net cumulative
deficiency.........$ (45,992) $ (36,047) $ (25,973) $ (11,559) $ (3,590) $ (158) $ (2,260) $ (5,976) $ (5,155) $ -
Supplemental gross data:
Gross liability after reclassification of
pools - end of year...............................$ 225,610 $ 179,815 $ 156,060 $ 128,794 $ 79,639 $ 74,929 $ 80,909
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 $ 80,909
Reinsurance recoverable............................. 86,772 64,436 57,468 46,777 14,432 10,876 28,970
---------- ---------- ---------- ---------- ---------- ---------- ----------
Net liability - end of year (1).....................$ 119,963 $ 99,685 $ 98,592 $ 82,017 $ 65,207 $ 64,053 $ 51,939
========== ========== ========== ========== ========== ========== ==========
Gross re-estimated liability - latest (1)...........$ 210,499 $ 162,687 $ 155,466 $ 132,309 $ 91,940 $ 84,131
Re-estimated recoverable - latest................... 78,977 59,412 56,716 48,032 20,757 14,923
---------- ---------- ---------- ---------- ---------- ----------
Net re-estimated liability - latest (1).............$ 131,522 $ 103,275 $ 98,750 $ 84,277 $ 71,183 $ 69,208
========== ========== ========== ========== ========== ==========
Gross cumulative (deficiency) redundancy............$ (3,764) $ 1,434 $ 594 $ (3,515) $ (12,301) $ (9,202)
========== ========== ========== ========== ========== ==========
- ------------------------------------------------------
<FN>
(1) The December 31, 1993 and prior amounts do not include the reclassification of pool liabilities.
</TABLE>
<PAGE>
PAGE 7
TRUST ARRANGEMENTS AND SPECIAL DEPOSITS
Under the reinsurance arrangements with NAICO, CIB 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 losses and loss adjustment expenses paid and
outstanding, unpaid losses and loss adjustment expenses and unearned premium
reserves 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 those states. 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 income 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.
Declines in the fair value of investment securities below their carrying
value that are other than temporary are recognized in earnings.
As of December 31, 1998, all of the investments of CIB 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), 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
$24.9 million of CIB's portfolio at December 31, 1998. The remainder is
managed by the Investment Committee of the Company's Board of Directors.
Approximately $77.5 million of NAICO's investment portfolio at December 31,
1998 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.
RECENT DEBENTURE OFFERING
Chandler (U.S.A.), Inc. ("Chandler USA"), a wholly owned subsidiary of
CIB, is offering debentures in the aggregate principal amount of $24,000,000
(the "Debentures"). The terms of the Debentures including the interest rate
and redemption date have not been determined. Chandler USA plans to use the
proceeds of the offering to repay amounts due to CIB; to retire Chandler
USA's existing bank debt; and for general corporate purposes. The Debentures
are subject to certain transfer restrictions. The Company and its
subsidiaries and affiliates, other than Chandler USA, are not obligated by
the Debentures. Accordingly, the Debentures are effectively subordinated to
all existing and future liabilities and obligations of Chandler USA's
existing and future subsidiaries.
EMPLOYEES AND ADMINISTRATION
The Company and CIB 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 CIB's 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 CIB, is the Financial Director of CIM and the
Treasurer and a director of CIM Barbados.
At December 31, 1998, the subsidiaries of the Company organized under
the laws of the United States had approximately 357 full-time employees.
The subsidiaries have generally enjoyed good relations with their employees.
<PAGE>
PAGE 8
COMPETITION
NAICO operates in a highly competitive industry and faces competition
from domestic and foreign insurers, many of which are larger, have greater
financial, marketing and management resources, have more favorable ratings
by ratings agencies and offer more diversified insurance coverages than NAICO.
A company's capacity to write insurance policies is dependent on a
variety of factors including its net worth or "surplus," the lines of business
written, the types of risk insured and its profitability. Since the late
1980's, the industry has generally had excess underwriting capacity. This
condition has resulted in depressed premium rates and expanded policy terms,
which generally occur when excess underwriting capacity exists. NAICO
continues to experience pricing competition as the conditions of heightened
price competition and impaired underwriting performance continue in the
industry as a whole.
REGULATION
REGULATION IN GENERAL
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, unpaid losses and loss adjustment expenses or for other
purposes, limitations on types and amounts of investments, restrictions on the
size of risks which may be insured by a single company, licensing of insurers
and agents, deposits of securities for the benefit of policyholders and the
filing of periodic reports with respect to financial condition and other
matters. In addition, regulatory examiners perform periodic financial and
market conduct examinations of insurance companies. Such regulation is
generally intended for the protection of policyholders rather than
shareholders or creditors.
NAICO is required to deposit securities with regulatory agencies in
several states in which it is licensed as a condition of conducting operations
in those states.
In addition to the regulatory oversight of the Company's insurance
subsidiaries, the Company is also subject to regulation under the laws of the
Cayman Islands and the Company and all of its affiliates are subject to
regulation under the Nebraska Insurance Holding Company System Act (the
"Holding Company Act"). The Holding Company Act contains certain reporting
requirements including those requiring 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.
NAICO is also affected by a variety of state and federal legislative and
regulatory measures and judicial decisions that define and extend the risks
and benefits for which insurance is sought and provided. These include
redefinitions of risk exposure in areas such as product liability,
environmental damage and workers compensation. In addition, individual state
insurance departments may prevent premium rates for some classes of insureds
from reflecting the level of risk assumed by the insurer for those classes.
Such developments may adversely affect the profitability of various lines of
insurance. In some cases, these adverse effects on profitability can be
minimized through coverage repricing, if permitted by applicable regulations,
or limitations or cessation of the affected business.
The Company and NAICO Indemnity (Cayman), Ltd. ("NAICO Indemnity"), a
wholly owned subsidiary of the Company, hold Unrestricted Class "B" Insurer's
Licenses under provisions of the Insurance Law (1998 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 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.<PAGE>
<PAGE>
PAGE 9
CIB 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 annual taxes, 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. CIB 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.
INSURANCE REGULATION CONCERNING CHANGE OR ACQUISITION OF CONTROL
NAICO is a domestic property and casualty insurance company organized
under the insurance laws of Nebraska (the "Insurance Code"). The Insurance
Code provides that the acquisition or change of "control" of a domestic
insurer or of any person that controls a domestic insurer cannot be
consummated without the prior approval of the Nebraska Department of
Insurance. A person seeking to acquire control, directly or indirectly,
of a domestic insurance company or of any person controlling a domestic
insurance company must generally file with the relevant insurance regulatory
authority an application for change of control containing certain
information required by statute and published regulations and provide a
copy of such to the domestic insurer. In Nebraska, control is generally
presumed to exist if any person, directly or indirectly, owns, controls,
holds with the power to vote or holds proxies representing 10% or more of
the voting securities of the insurance company or of any other person or
entity controlling the insurance company. The 10% presumption is not
conclusive and control may be found to exist at less than 10%.
In addition, many state insurance regulatory laws contain provisions
that require pre-notification to state agencies of a change in control of a
non-domestic insurance company admitted in that state. While such
pre-notification statutes do not authorize the state agency to disapprove the
change of control, such statutes do authorize issuance of a cease and desist
order with respect to the non-domestic insurer if certain conditions exist
such as undue market concentration.
Any future transactions that would constitute a change in control of
the Company would also generally require prior approval by the Nebraska
Department of Insurance and would require pre-acquisition notification in
those states which have adopted pre-acquisition notification provisions and
in which the insurers are admitted. Because such requirements are primarily
for the benefit of policyholders, they may deter, delay or prevent certain
transactions that could be advantageous to the shareholders or creditors of
the Company.
RESTRICTIONS ON SHAREHOLDER DIVIDENDS
A significant portion of the Company's consolidated assets represents
assets of the Company's insurance subsidiaries that may not be immediately
transferable to the holding company in the form of shareholder dividends,
loans, advances or other payments. 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.
Statutes and regulations governing NAICO and other insurance companies
domiciled in Nebraska regulate the payment of shareholder dividends and other
payments by NAICO to Chandler USA. Under applicable Nebraska statutes and
regulations, NAICO is permitted to pay shareholder dividends only out of
statutory earned surplus. To the extent NAICO has statutory earned surplus,
NAICO may pay shareholder dividends only to the extent that such dividends
are not defined as extraordinary dividends or distributions. If the
dividends are, under applicable statutes and regulations, extraordinary
dividends or distributions, regulatory approval must be obtained. Under the
applicable Nebraska statute, and subject to the availability of statutory
earned surplus, the maximum shareholder dividend that may be declared (or
cash or property distribution that may be made) by NAICO in any one calendar
year without regulatory approval is the greater of (i) NAICO's statutory net
income, excluding realized capital gains, for the preceding calendar year
plus statutory net income, excluding realized capital gains, from the second
and third preceding calendar years, that was not paid in dividends or other
distributions; or (ii) 10% of NAICO's statutory policyholders' surplus as of
the preceding calendar year end, not to exceed NAICO's statutory earned
surplus.
As of December 31, 1998, NAICO had statutory earned surplus of $12.6
million. Applying the Nebraska statutory limits described above, the maximum
shareholder dividend NAICO may pay in 1999 without approval of the Nebraska
Department of Insurance is $7.3 million. The maximum shareholder dividend
that NAICO could have paid in 1998 was $8.1 million; however, $6.0 million in
shareholder dividends were paid by NAICO to Chandler USA in 1998. The
maximum shareholder dividend that NAICO could have paid in 1997 and 1996,
respectively, was $4.2 million and $4.0 million; NAICO did not pay any
shareholder dividends during those years.
In addition to the statutory limits described above, the amount of
shareholder dividends and other payments to affiliates permitted can be
further limited by contractual or regulatory restrictions or other agreements
with regulatory authorities restricting dividends and other payments, including
regulatory restrictions that are imposed as a matter of
administrative policy. If insurance regulators determine that payment of a
shareholder dividend or other payments to an affiliate (such as payments under
a tax sharing agreement, payments for employee or other services, or payments
pursuant to a surplus note) would be hazardous to such insurance company's
policyholders or creditors, the regulators may block such payments that would
otherwise be permitted without prior approval.
<PAGE>
PAGE 10
The payment of cash dividends by CIB is limited to its realized earned
surplus and margin of solvency requirements. CIB has not paid any cash
shareholder dividends.
RISK-BASED CAPITAL
The National Association of Insurance Commissioners has adopted a
methodology for assessing the adequacy of statutory surplus of domestic
property and casualty insurers. This methodology is described in the Risk
Based Capital Model Act (the "RBC Model Act"), a model recommended by the
National Association of Insurance Commissioners for adoption. The RBC Model
Act includes a risk-based capital requirement that requires insurance
companies to calculate and report information under a risk-based formula
which attempts to measure statutory capital and surplus needs based on the
risks in the insurance company's mix of products and investment portfolio.
The formula is designed to allow state insurance regulators to identify
potential under-capitalized companies. Under the formula, an insurer
determines its "risk-based capital" ("RBC") by taking into account certain
risks related to the insurer's assets (including risks related to its
investment portfolio and ceded reinsurance) and the insurer's liabilities
(including underwriting risks related to the nature and experience of its
insurance business). The RBC rules provide for different levels of
regulatory attention depending on the ratio of a company's total adjusted
capital to its "authorized control level" of RBC. Insurers below the
specific ratios are classified within certain levels, each of which requires
specific corrective action. The levels and ratios are as follows:
<TABLE>
<CAPTION>
Ratio of Total Adjusted Capital to
Authorized Control Level RBC
Regulatory Event (1) (Less than or equal to)
-------------------- ----------------------------------
<S> <C>
Company Action Level (2)............... 2.0
Regulatory Action Level (3)............ 1.5
Authorized Control Level (4)........... 1.0
Mandatory Control Level (5)............ 0.7
-----------------------
<FN>
(1) When an insurer's ratio exceeds 2.0, it is not subject to regulatory
attention under the RBC Model Act.
(2) "Company Action Level" requires an insurer to prepare and submit an
RBC Plan to the insurance commissioner of their state of domicile.
After review, the insurance commissioner will notify the insurer if the
Plan is satisfactory.
(3) "Regulatory Action Level" requires the insurer to submit an RBC Plan, or
if applicable, a Revised RBC Plan to the insurance commissioner of their
state of domicile. After examination or analysis, the insurance
commissioner will issue an order specifying corrective actions to be
taken.
(4) "Authorized Control Level" authorizes the insurance commissioner to take
such regulatory actions considered necessary to protect the best interest
of the policyholders and creditors of an insurer which may include the
actions necessary to cause the insurer to be placed under regulatory
control (i.e., rehabilitation or liquidation).
(5) "Mandatory Control Level" authorizes the insurance commissioner to take
actions necessary to place the insurer under regulatory control (i.e.,
rehabilitation or liquidation).
</TABLE>
The ratios of total adjusted capital to authorized control level RBC for NAICO
were 5.9:1 and 7.5:1 at December 31, 1997 and 1998, respectively.
Therefore, NAICO's capital exceeds the level that would trigger regulatory
attention pursuant to the risk-based capital requirement.
NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS-IRIS RATIOS
The National Association of Insurance Commissioners Insurance Regulatory
Information System ("IRIS") was developed by a committee of state insurance
regulators and is primarily intended to assist state insurance departments
in executing their statutory mandates to oversee the financial condition of
insurance companies operating in their respective states. IRIS identifies 11
industry ratios and specifies "usual values" for each ratio. Departure from
the "usual values," which fluctuate annually, on four or more ratios generally
leads to inquiries from individual state insurance commissioners. NAICO had
three 1998 ratios that were outside of the "usual values." In 1998, NAICO
experienced a "change in net writings" of minus 43%, compared to a usual value
of plus or minus 33%. NAICO's gross premiums written during 1998 increased
9%; however, the purchase of additional reinsurance coverages resulted in
significantly lower net premiums written. NAICO's "surplus aid to surplus"
during 1998 was 15% compared to a usual value of less than 15%. Ceding
commissions received from reinsurers increased significantly during 1998 due
to the purchase of additional reinsurance coverages. NAICO's "investment
yield" as calculated using the IRIS formula was 4.2% during 1998 compared to a
usual value of 4.5% to 10%. NAICO maintains a high-quality investment
portfolio, approximately 19% of which was invested in tax-exempt bonds as of
December 31, 1998. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS" and "Reinsurance." NAICO had no ratios
which varied from the "usual value" ranges in 1997.
<PAGE>
PAGE 11
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, CIB 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. CIB is required to pay an
annual license fee. The Company, NAICO Indemnity and CIB 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 the Company, NAICO Indemnity and CIB 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 (including premium and investment 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.
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 CIB's stock entitled to vote or 25% or more of the
total value of CIB's stock, then each such person is required to include in
his gross income a portion of any insurance income of CIB 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
CIB ("related person insurance income" or "RPII"). Under these rules, all
U.S. persons who own stock in the Company would generally be required,
subject to the exception discussed hereinafter, to include in their gross
incomes a portion of the RPII received by CIB from NAICO. However, related
person insurance income of CIB 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 CIB's taxable year, less than 20% of the total combined voting
power of all classes of stock of CIB and less than 20% of the total value of
CIB is owned (directly or indirectly) by persons who are (directly or
indirectly) insured under any policy of insurance or reinsurance issued by
CIB, or who are related persons to any such person.
<PAGE>
PAGE 12
In connection with its examination of the 1992 federal income tax return
of Chandler USA, the Internal Revenue Service (the "IRS") contended that CIB
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 CIB,
and the Company is a related party to NAICO, which purchases reinsurance
from CIB. 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 CIB 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 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 1996, 1997 and 1998.
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 are 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 1996, 1997 and 1998.
UNITED STATES INCOME TAXATION OF THE COMPANY AND ITS SUBSIDIARIES.
CIB is organized and endeavors to conduct its business from Barbados and
not within the United States. Accordingly, CIB does not presently file
United States income tax returns. Pursuant to United States Treasury
Regulations, CIB 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 CIB 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 CIB in the United States. If CIB 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) CIB may be subject to an additional
"branch profits tax" on deemed dividend equivalents and interest
payments, and (ii) CIB's 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. CIB has not
filed a return for the taxable years ended prior to July 31, 1990.
Regardless of whether CIB 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 CIB, at a 5% rate. The United States
person responsible for payment of such items of income to CIB is obligated
to withhold this tax before payment is made to CIB.
<PAGE>
PAGE 13
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 CIB should not be deductible and that
instead, to the extent of Chandler USA'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 CIB
exceeded an arm's length premium, such excess amount would probably be
characterized as a distribution by Chandler USA to CIB with the result that
the United States consolidated group would not be permitted a deduction, and
CIB would be subject to a 5% withholding tax with respect to such excess
amount.
Any determination that CIB was engaged in business in the United States,
any disallowance of deductions for most or all of the reinsurance premiums
paid by NAICO to CIB or any substantial reallocation of income from CIB
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.
DISPOSITIONS OF COMMON SHARES. Subject to the discussion below
relating to the potential application of Section 1248 of the Code, a United
States shareholder will generally, upon the sale or exchange of any common
shares of the Company, recognize a gain or loss for United States income tax
purposes equal to the difference between the amount realized upon such sale
or exchange and the shareholder's basis in the common shares of the Company.
If the shareholder's holding period for such common shares of the Company is
more than 12 months, any gain will be subject to tax at a current maximum
marginal tax rate of 20% for individuals and 35% for corporations.
Section 1248 of the Code provides that if a United States person
disposes of stock in a foreign corporation and such person owned
directly, indirectly or constructively 10% or more of the voting shares of
the corporation at any time during the five-year period ending on the date of
disposition when the corporation was a CFC, any gain from the sale or
exchange of the shares may be treated as ordinary income to the extent of
the CFC's previously untaxed earnings and profits during the period that the
shareholder held the shares (with certain adjustments). A 10% United
States shareholder may in certain circumstances be required to report a
disposition of shares of a CFC by attaching IRS Form 5471 to the United
States income tax or information return that the shareholder would normally
file for the taxable year in which the disposition occurs.
Section 953(c)(7) of the Code generally provides that Section 1248 will
also apply to any sale or exchange of shares in a foreign corporation that
earns RPII if the foreign corporation would be taxed as an insurance company
if it were a domestic corporation, regardless of whether the selling
shareholder is or was a 10% shareholder or whether RPII constitutes
20% or more of the corporation's gross insurance income. Existing
treasury regulations do not address whether Section 1248 of the Code and
the requirement to file Form 5471 would apply if the foreign corporation
is not a CFC but the foreign corporation has a subsidiary that is a CFC or
that would be taxed as an insurance company if it were a domestic
corporation (although, as discussed above, shareholders of 10% or more of the
common shares of the Company may have an independent obligation to file Form
5471).
The foregoing discussion is based upon current law. The tax treatment
of a shareholder of common shares of the Company, or a person treated as a
shareholder of common shares of the Company for United States federal income,
state, local or non-United States tax purposes, may vary depending on the
owner's particular tax situation. Legislative, judicial or administrative
changes or interpretations may be forthcoming that could be retroactive and
could affect the tax consequences to owners of common shares of the Company.
SHAREHOLDERS SHOULD CONSULT THEIR OWN TAX ADVISORS CONCERNING THE UNITED
STATES FEDERAL, STATE, LOCAL AND NON-UNITED STATES TAX CONSEQUENCES OF
OWNERSHIP AND DISPOSITION OF THE COMMON SHARES OF THE COMPANY.
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.
During 1998, the IRS conducted an examination of the 1995 U.S. Federal
income tax return of CIB. The IRS completed the examination in the third
quarter of 1998 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. CIB's principal office is
located in the Stevmar House, Rockley, Christ Church, Barbados. The
Company and CIB 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, and an additional office building with
approximately 46,000 square feet of usable space is planned for construction
in Chandler, Oklahoma during 1999. The Company's subsidiaries also lease
approximately 11,000 square feet in the aggregate for its branch offices.
The Company believes such space will suffice for the foreseeable future.
<PAGE>
PAGE 14
ITEM 3. LEGAL PROCEEDINGS
CENTRA LITIGATION
The Company and its affiliates have been involved in litigation with
CenTra and certain of its affiliates, officers and directors (the "CenTra
Group") since July 1992. See Note 11 to Consolidated Financial Statements
for a detailed discussion. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CenTra Litigation."
OTHER LITIGATION
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 1999.
<PAGE>
PAGE 15
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.
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, 1997.
<TABLE>
<CAPTION>
1998 HIGH LOW 1997 HIGH LOW
- ------------------ ------ ------ ------------------ ------ ------
<S> <C> <C> <S> <C> <C>
First Quarter..... $ 8.38 $ 5.13 First Quarter..... $ 5.94 $ 5.13
Second Quarter.... 8.00 7.19 Second Quarter.... 5.75 4.13
Third Quarter..... 8.13 6.75 Third Quarter..... 6.00 3.88
Fourth Quarter.... 7.88 7.00 Fourth Quarter.... 5.75 4.88
</TABLE>
The closing market price of the common shares on The NASDAQ Stock Market
on March 29, 1999 was $8.63 per share.
SHAREHOLDERS
As of February 28, 1999, there were 152 shareholders of record and
approximately 466 beneficial holders of the Company's common shares, and
the number of common shares issued was 6,941,708 shares, which includes
544,475 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. Noncompliance 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. See
"BUSINESS - Regulation - Restrictions on 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. CIB
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."
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 CIB 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.
<PAGE>
PAGE 16
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, 1997 and 1998, and the related consolidated statements of
operations, comprehensive income, shareholders' equity and cash flows for each
of the three years in the period ended December 31, 1998, have been audited by
Deloitte & Touche, independent auditors whose independent auditors report
expresses an unqualified opinion and includes an explanatory paragraph
relating to litigation. 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,
------------------------------------------------
1994 1995 1996 1997 1998
-------- -------- -------- -------- --------
(Amounts in thousands except
per share data and percentages)
<S> <C> <C> <C> <C> <C>
OPERATING DATA
Revenues
Net premiums earned (1)....$ 81,597 $ 81,087 $ 89,286 $ 94,679 $ 70,064
Interest income, net....... 8,182 7,641 7,199 7,253 6,467
Realized investment
gains, net............... 493 412 140 764 1,163
Commissions, fees and
other income............. 2,861 3,095 3,620 2,528 1,952
--------- --------- --------- --------- ---------
Total revenues................. 93,133 92,235 100,245 105,224 79,646
--------- --------- --------- --------- ---------
Operating expenses
Losses and loss
adjustment expenses...... 55,872 50,543 53,391 57,512 47,879
Policy acquisition costs... 20,372 23,995 32,123 28,145 17,033
General and administrative
expenses................. 12,649 12,770 14,038 13,116 12,710
Interest expense........... 2 52 146 463 936
Litigation expenses, net... 1,921 285 (108) 4,772 (2,707)
--------- --------- --------- --------- ---------
Total operating expenses....... 90,816 87,645 99,590 104,008 75,851
--------- --------- --------- --------- ---------
Income before income taxes..... 2,317 4,590 655 1,216 3,795
Net income (loss)..............$ 2,474 $ 3,778 $ 972 $ (1,065) $ 3,442
========= ========= ========= ========= =========
Diluted earnings (loss) per
common share...............$ 0.36 $ 0.54 $ 0.14 $ (0.16) $ 0.53
Diluted weighted average
common shares outstanding.. 6,942 6,942 6,942 6,687 6,438
Combined loss and underwriting
expense ratio (2).......... 103% 101% 106% 100% 105%
BALANCE SHEET DATA
Cash and investments...........$124,501 $122,561 $119,136 $125,063 $120,812
Total assets................... 261,364 246,949 206,827 210,790 236,025
Unpaid losses and loss
adjustment expenses........ 156,060 128,794 79,639 74,929 80,909
Notes payable.................. - 300 4,391 2,796 9,410
Litigation liabilities......... - - - 16,618 13,228
Total liabilities.............. 197,905 173,499 134,280 152,455 173,960
Stock held by subsidiary,
at cost.................... (2,148) (2,148) - (2,487) (2,905)
Stock rescinded through
litigation................ - - - (11,799) (11,799)
Shareholders' equity........... 63,459 73,450 72,547 58,335 62,065
Book value per share (3)....... 9.14 10.58 10.45 12.19 13.05
- -------------------------------
<FN>
(1) During 1997 and 1998, the Company purchased additional reinsurance
coverages which resulted in significantly lower net premiums earned.
See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS."
(2) Litigation expenses are not considered underwriting expenses; therefore,
such expenses have been excluded from this ratio. The 1996 underwriting
expense ratio was increased by four 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."
(3) Based on total common shares outstanding and common stock to be issued,
less stock held by subsidiary and stock rescinded through litigation.
See Note 11 to Consolidated Financial Statements.
</TABLE>
<PAGE>
PAGE 17
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.
CLAIM COSTS AND LOSS RESERVES
Insurance companies provide in their financial statements reserves for
unpaid losses and loss adjustment expenses which are estimates of the expense
of investigation and settlement of all reported and incurred but not reported
losses under their previously issued insurance policies and reinsurance
contracts. In estimating reserves, insurance companies use various
standardized methods based on historical experience and payment and reporting
patterns for the type of risk involved. The application of these methods
necessarily involves subjective determinations by the personnel of the
insurance company. Inherent in the estimates of the ultimate liability for
unpaid claims are expected trends in claim severity, claim frequency and
other factors that may vary as claims are settled. The amount of and
uncertainty in the estimates are affected by such factors as the amount of
historical claims experience relative to the development period for the type
of risk, knowledge of the actual facts and circumstances, and the amount of
insurance risk retained. The ultimate cost of insurance claims can be
adversely affected by increased costs, such as medical expenses, repair
expenses, costs of providing legal defense for policyholders, increased jury
awards and court decisions and legislation that 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 CIB and the methods used to arrive
at such reserve estimates. NAICO also retains independent professional
actuaries who review such reserve estimates and methods. Any changes in the
estimates are reflected in current operating results. See Notes to
Consolidated Financial Statements.
The loss settlement period on insurance claims for property damage is
relatively short. The more severe losses for bodily injury and workers
compensation claims have a much longer loss settlement period and may be paid
out over several years. It is often necessary to adjust estimates of
liability on a loss either upward or downward between the time a claim arises
and the time of payment. Workers compensation indemnity benefit reserves are
determined based on statutory benefits prescribed by state law and are
estimated based on the same factors generally discussed above, which may
include, where state law permits, inflation adjustments for rising benefits
over time. Generally, the more costly automobile liability claims involve one
or more severe bodily injuries or deaths. The ultimate cost of these types
of claims is dependent on various factors including the relative liability of
the parties involved, the number and severity of injuries, and the legal
jurisdiction where the incident occurred.
NAICO does not ordinarily insure against environmental matters as that
term is commonly used. However, in some cases, regulatory filings made on
behalf of an insured can make NAICO directly liable to the regulatory
authority for property damage, which could include environmental pollution.
In those cases, NAICO ordinarily has recourse against the insured or the
surety bond principal for amounts paid. NAICO has insured certain trucking
companies and pest control operators who are required to provide proof of
insurance which in some cases assures payment for cleanup and restoration
of damage resulting from sudden and accidental release or discharge of
contaminants or other substances which may be classified as pollutants.
NAICO also provides surety bonds for construction contractors who use or
have control of such substances and for contractors who remove and dispose
of asbestos as a part of their contractual obligations.
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. CIB reinsures a portion of those risks. NAICO maintains
claims records which segregate this type of risk for the purpose of
evaluating environmental risk exposure. Based upon the nature of such
lines of business with NAICO's insureds, and current data regarding the
limited severity and infrequency of such matters, it appears that potential
environmental risks are not a significant portion of claims reserves and
therefore would not likely have a material adverse impact, if any, on the
financial condition of the Company.
The Company's subsidiaries report their reserves on the basis of U.S.
GAAP. NAICO's statutory-based reserves (reserves calculated in accordance
with accounting practices prescribed or permitted by an insurer's
domiciliary state insurance regulatory authorities for purposes of
financial reporting to regulators) do not differ from its reserves
reported on the basis of U.S. GAAP. Neither NAICO nor CIB discounts its
reserves for unpaid losses and loss adjustment expenses. See Notes to
Consolidated Financial Statements.
<PAGE>
PAGE 18
ECONOMIC CONDITIONS
The impact of a recession on the Company 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 $111 million, or 82%, of NAICO's direct
written premiums in 1998 were in the states of Oklahoma and Texas. An
economic downturn in these states could have a significant adverse impact on
the Company. A recession might also cause defaults on fixed-income securities
owned by NAICO or CIB. Management believes it has mitigated the impact of a
recession by employing conservative underwriting practices and strict credit
policies and maintaining a high-quality investment portfolio.
Periods of inflation have varying effects on 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 1996 through 1998.
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, unpaid losses and loss adjustment expenses or for other
purposes, limitations on types and amounts of investments, restrictions on the
size of risks which may be insured by a single company, licensing of insurers
and agents, deposits of securities for the benefit of policyholders and the
filing of periodic reports with respect to financial condition and other
matters. In addition, regulatory examiners perform periodic examinations of
insurance companies. Such regulation is generally intended for the protection
of policyholders rather than shareholders or creditors.
In addition to the regulatory oversight of 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.
Control is generally presumed to exist if any person, directly or indirectly,
owns, controls, holds with the power to vote or holds proxies representing
10% or more of the voting securities of the insurance company or of any other
person or entity controlling the insurance company. The 10% presumption is
not conclusive and control may be found to exist at less than 10%. Persons
owning any securities of 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 the redefinition of risk exposure in areas such as product
liability, environmental damage and workers compensation. In addition,
individual state insurance departments may prevent premium rates for some
classes of insureds from reflecting the level of risk assumed by the insurer
for those classes. Such developments may adversely affect the profitability
of various lines of insurance. In some cases, these adverse effects on
profitability can be minimized through coverage repricing, if permitted by
applicable regulations, or limitations or cessation of the affected business.
<PAGE>
PAGE 19
COMPETITION
NAICO operates in a highly competitive industry and faces competition
from domestic and foreign insurers, many of which are larger, have greater
financial, marketing and management resources, have more favorable ratings by
ratings agencies and offer more diversified insurance coverages than NAICO.
A company's capacity to write insurance policies is dependent on a
variety of factors including its net worth or "surplus," the lines of
business written, the types of risk insured and its profitability. Since the
late 1980's, the industry has generally had excess underwriting capacity.
This condition has resulted in depressed premium rates and expanded policy
terms, which generally occur when excess underwriting capacity exists. NAICO
continues to experience pricing competition as the conditions of heightened
price competition and impaired underwriting performance continue in the
industry as a whole.
ANALYSIS OF INSURANCE PROGRAM RESULTS OF OPERATIONS
The following tables summarize the net premiums earned and the financial
year (losses incurred and recognized by 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:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
INSURANCE PROGRAMS 1996 1997 1998
- ----------------------------------------- ---------- ---------- ----------
(Dollars in thousands)
<S> <C> <C> <C>
STANDARD PROPERTY AND CASUALTY
Net premiums earned.................... $ 38,330 $ 55,527 $ 41,662
Financial year loss & LAE ratio........ 59.0 % 67.1 % 75.4 %
Accident year loss & LAE ratio......... 63.4 % 67.4 % 67.2 %
POLITICAL SUBDIVISIONS
Net premiums earned.................... $ 14,017 $ 14,945 $ 13,073
Financial year loss & LAE ratio........ 57.6 % 56.8 % 80.3 %
Accident year loss & LAE ratio......... 68.2 % 62.5 % 70.8 %
SURETY BONDS
Net premiums earned.................... $ 10,020 $ 11,117 $ 9,938
Financial year loss & LAE ratio........ (0.7)% 8.6 % 15.8 %
Accident year loss & LAE ratio......... 39.6 % 11.3 % 18.6 %
GROUP ACCIDENT AND HEALTH
Net premiums earned.................... $ 316 $ 2,303 $ 4,646
Financial year loss & LAE ratio........ 47.9 % 43.3 % 89.3 %
Accident year loss & LAE ratio......... 99.5 % 68.9 % 72.5 %
NONSTANDARD PRIVATE-PASSENGER AUTOMOBILE
Net premiums earned.................... $ 16,595 $ 8,841 $ 482
Financial year loss & LAE ratio........ 86.2 % 72.2 % (37.8)%
Accident year loss & LAE ratio......... 84.2 % 62.7 % 20.3 %
OTHER
Net premiums earned.................... $ 10,008 $ 1,946 $ 263
Financial year loss & LAE ratio........ 82.9 % 176.4 % 161.3 %
Accident year loss & LAE ratio......... 50.0 % 79.4 % 68.5 %
TOTAL
Net premiums earned.................... $ 89,286 $ 94,679 $ 70,064
Financial year loss & LAE ratio........ 59.8 % 60.7 % 68.3 %
Accident year loss & LAE ratio......... 64.0 % 59.9 % 61.0 %
</TABLE>
<PAGE>
PAGE 20
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
LINES OF INSURANCE 1996 1997 1998
- ----------------------------------------- ---------- ---------- ----------
(Dollars in thousands)
<S> <C> <C> <C>
WORKERS COMPENSATION
Net premiums earned.................... $ 42,813 $ 44,954 $ 19,651
Financial year loss & LAE ratio........ 53.1 % 66.3 % 70.6 %
Accident year loss & LAE ratio......... 56.1 % 70.4 % 62.6 %
AUTOMOBILE LIABILITY
Net premiums earned.................... $ 17,581 $ 15,593 $ 14,139
Financial year loss & LAE ratio........ 97.6 % 89.1 % 75.0 %
Accident year loss & LAE ratio......... 77.1 % 70.8 % 72.9 %
OTHER LIABILITY
Net premiums earned.................... $ 8,656 $ 12,209 $ 14,045
Financial year loss & LAE ratio........ 59.9 % 48.5 % 70.1 %
Accident year loss & LAE ratio......... 73.1 % 44.0 % 52.9 %
SURETY
Net premiums earned.................... $ 10,123 $ 11,256 $ 10,101
Financial year loss & LAE ratio........ (0.6)% 8.7 % 15.9 %
Accident year loss & LAE ratio......... 39.4 % 11.4 % 18.8 %
AUTOMOBILE PHYSICAL DAMAGE
Net premiums earned.................... $ 6,788 $ 5,726 $ 4,702
Financial year loss & LAE ratio........ 73.6 % 59.8 % 85.3 %
Accident year loss & LAE ratio......... 76.5 % 60.7 % 84.3 %
ACCIDENT AND HEALTH
Net premiums earned.................... $ 564 $ 2,529 $ 4,646
Financial year loss & LAE ratio........ 56.1 % 43.1 % 90.9 %
Accident year loss & LAE ratio......... 90.5 % 70.6 % 72.5 %
PROPERTY
Net premiums earned.................... $ 1,467 $ 1,912 $ 2,332
Financial year loss & LAE ratio........ 113.8 % 74.1 % 135.8 %
Accident year loss & LAE ratio......... 108.6 % 77.9 % 128.0 %
INLAND MARINE
Net premiums earned.................... $ 1,294 $ 500 $ 448
Financial year loss & LAE ratio........ 114.7 % 194.6 % 122.8 %
Accident year loss & LAE ratio......... 150.4 % 122.9 % 103.5 %
TOTAL
Net premiums earned.................... $ 89,286 $ 94,679 $ 70,064
Financial year loss & LAE ratio........ 59.8 % 60.7 % 68.3 %
Accident year loss & LAE ratio......... 64.0 % 59.9 % 61.0 %
</TABLE>
PURCHASE OF ADDITIONAL REINSURANCE
In 1998, NAICO believed that reinsurance market conditions were conducive
to the purchase of additional reinsurance. During the first quarter of 1998,
NAICO purchased additional reinsurance under its workers compensation and
casualty reinsurance programs. During the second quarter of 1998, NAICO
purchased additional reinsurance for its construction surety bond
reinsurance program.
During the second quarter of 1997, management concluded that it would be
in NAICO's best interest to substantially reduce its underwriting risk in the
California portion of the nonstandard private-passenger automobile program.
In July 1997, NAICO purchased additional reinsurance for this portion of the
program.
The purchase of the additional reinsurance coverages in 1997 and 1998
substantially reduced the per occurrence retention for NAICO's workers
compensation, casualty, surety bond and nonstandard private-passenger
automobile lines of business, but resulted in significantly lower net
premiums earned, losses and loss adjustment expenses and policy
acquisition costs. See "Premiums Earned" and "Policy Acquisition Costs."
<PAGE>
PAGE 21
PREMIUMS EARNED
The following tables set forth premiums earned on a gross basis (before
reductions for premiums ceded to reinsurers) and on a net basis (after such
reductions) for each insurance program as well as each line of insurance as
of December 31 for each year presented:
<TABLE>
<CAPTION>
INSURANCE PROGRAMS GROSS PREMIUMS EARNED NET PREMIUMS EARNED
- ------------------------------------------ ------------------------------ ------------------------------
1996 1997 1998 1996 1997 1998
-------- -------- -------- -------- -------- --------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Standard property and casualty............ $ 45,066 $ 62,841 $ 76,458 $ 38,330 $ 55,527 $ 41,662
Political subdivisions.................... 19,314 21,503 25,091 14,017 14,945 13,073
Surety bonds.............................. 11,416 12,320 11,915 10,020 11,117 9,938
Group accident and health................. 512 3,379 6,104 316 2,303 4,646
Nonstandard private-passenger automobile.. 16,595 14,303 6,016 16,595 8,841 482
Other..................................... 10,311 2,363 487 10,008 1,946 263
-------- -------- -------- -------- -------- --------
TOTAL..................................... $103,214 $116,709 $126,071 $ 89,286 $ 94,679 $ 70,064
======== ======== ======== ======== ======== ========
<CAPTION>
LINES OF INSURANCE GROSS PREMIUMS EARNED NET PREMIUMS EARNED
- ------------------------------------------ ------------------------------ ------------------------------
1996 1997 1998 1996 1997 1998
-------- -------- -------- -------- -------- --------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Workers compensation...................... $ 47,248 $ 47,198 $ 48,699 $ 42,813 $ 44,954 $ 19,651
Automobile liability...................... 17,898 20,672 20,005 17,581 15,593 14,139
Other liability........................... 9,412 13,593 17,593 8,656 12,209 14,045
Surety.................................... 11,519 12,459 12,078 10,123 11,256 10,101
Automobile physical damage................ 6,945 7,072 6,307 6,788 5,726 4,702
Accident and health....................... 830 3,697 6,111 564 2,529 4,646
Property.................................. 7,473 10,331 12,916 1,467 1,912 2,332
Inland marine............................. 1,889 1,687 2,362 1,294 500 448
-------- -------- -------- -------- -------- --------
TOTAL..................................... $103,214 $116,709 $126,071 $ 89,286 $ 94,679 $ 70,064
======== ======== ======== ======== ======== ========
</TABLE>
Gross premiums earned, before reductions for premiums ceded to
reinsurers, increased 9%, 13% and 8% in 1996, 1997 and 1998, respectively.
The increases are primarily attributable to increased production in
Oklahoma and Texas. Net premiums earned, after such reductions, increased
10% and 6% in 1996 and 1997, respectively, and decreased 26% in 1998. The
reduction in net premiums earned in 1998 was due primarily to the purchase
of additional reinsurance for NAICO's workers compensation, casualty and
nonstandard private-passenger automobile insurance programs described
previously. See "Purchase of Additional Reinsurance."
Gross premiums earned in the standard property and casualty program
increased 31%, 39% and 22% in 1996, 1997 and 1998, respectively. The
increases are primarily attributable to increased production in Oklahoma and
contiguous states, principally Texas. Net premiums earned increased 30% and
45% in 1996 and 1997, respectively, and decreased 25% in 1998, due primarily
to the purchase of additional reinsurance in 1998 as previously described.
Gross premiums earned in the political subdivisions program increased
13%, 11% and 17% in 1996, 1997 and 1998, respectively, due primarily to
expansion of the school districts portion of the program in Texas and
Missouri and increased production in Oklahoma. Net premiums earned
increased 12% and 7% in 1996 and 1997, respectively, and decreased 13% in
1998, due primarily to the purchase of additional reinsurance in 1998 as
previously described.
Gross premiums earned in the surety bond program decreased 31% in 1996,
increased 8% in 1997 and decreased 3% in 1998. Net premiums earned in the
surety bond program decreased 29% in 1996, increased 11% in 1997 and
decreased 11% in 1998. Net premiums earned from surety bonds produced by
L&W increased 58% and 22% in 1996 and 1997, respectively, and decreased 8%
in 1998. Increased competition, higher reinsurance costs and/or changes
in risk retained contributed to the decline in 1998. The remaining
reduction in 1998 was attributable to production and reinsurance
adjustments related to the runoff of a portion of the surety bond program
which was terminated on December 31, 1995.
During 1996, NAICO began writing excess accident and health coverage for
small to medium sized employers generally in Oklahoma and Texas. During
1997, NAICO began offering fully insured accident and health coverage on a
limited basis. Gross premiums earned in the group accident and health
program increased 560% and 81% in 1997 and 1998, respectively. Net premiums
earned in the group accident and health program increased 629% and 102% in
1997 and 1998, respectively. The significant increases in group accident
and health premiums are primarily the result of the growth expected in
start-up programs. NAICO is currently evaluating this program and may
modify or discontinue certain portions of this program in 1999.
<PAGE>
PAGE 22
Nonstandard private-passenger automobile gross premiums decreased 14% and
58% in 1997 and 1998, respectively. Net premiums earned in the nonstandard
private-passenger automobile premiums decreased 47% and 95% in 1997 and 1998,
respectively. During 1997, NAICO discontinued the Oklahoma and Arizona
portions of its nonstandard private-passenger automobile program. Effective
July 1, 1997, NAICO entered into a 100% quota share reinsurance agreement to
fully reinsure the risk in the California portion of the program. NAICO has
discontinued the California program.
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 direct
assignments to write workers compensation for such insureds in certain states
in lieu of participation in related pools. The majority of the change found
in the Company's other programs is attributable to participation in the pools
covering workers compensation and from direct assignments (included in
"Other" in the preceding table). Net premiums earned from the previously
mentioned mandatory pools and workers compensation assignments decreased 81%
and 93% in 1997 and 1998, respectively. The declines in 1997 and 1998 were
attributable to decreased activity from the pools and fewer assignments in
certain states. Both the size of the involuntary market and NAICO's relative
participation in states having a mandatory pool mechanism declined in these
years.
NET INTEREST INCOME AND NET REALIZED INVESTMENT GAINS
At December 31, 1998, the Company's investment portfolio consisted
primarily of fixed income U.S. Government, high-quality corporate and tax
exempt bonds, with approximately 9% invested in cash and money market
instruments. Income generated from this portfolio is largely dependent upon
prevailing levels of interest rates. The Company's portfolio contains no
junk bonds or real estate investments.
Net interest income decreased 6% in 1996, and increased 1% in 1997. Net
interest income decreased 11% in 1998, due primarily to lower interest rates
in 1998 and a reduction in invested assets due to the purchase of additional
reinsurance in 1998. In addition, during the fourth quarter of 1997 NAICO
shifted a portion of its fixed maturities portfolio from taxable to tax
exempt bonds (which generally have a lower before-tax yield). Income from
tax exempt securities was $1.0 million in 1998 as compared to $112,000 in
1997.
Net realized investment gains were $140,000, $764,000 and $1,163,000 in
1996, 1997 and 1998, respectively. Increased net realized investment gains
in 1997 resulted primarily from NAICO shifting a portion of its fixed
maturities portfolio from taxable to tax exempt bonds (which generally have a
lower yield) and NAICO's sale of common stock of Century Business Services,
Inc. The Century Business Services stock was received by NAICO in early 1997
as a part of a 1996 settlement with a former underwriting manager.
The average net yield on the portfolio, including net realized investment
gains, was 6.1%, 6.6% and 6.1% in 1996, 1997 and 1998, respectively. The
average net yield on the portfolio, excluding net realized investment gains,
was 6.0%, 5.9% and 5.2% for 1996, 1997 and 1998, respectively.
COMMISSIONS, FEES AND OTHER INCOME
The Company's income from commissions, fees and other income increased
17% in 1996, and decreased 30% and 23% for 1997 and 1998, respectively. The
majority of the Company's income from commissions, fees and other income are
from L&W's brokerage commissions and fees.
L&W's brokerage commissions and fees before intercompany eliminations
were $8.5 million in 1996, $9.0 million in 1997 and $8.5 million in 1998.
The decrease in 1998 is primarily a result of increased competition and
general declines in premium rates. A large portion of the brokerage
commissions and fees for L&W is incurred by NAICO and thus eliminated in the
consolidation of the Company's subsidiaries.
L&W disposed of certain equipment in 1998 that resulted in a gain of
approximately $145,000 before provision for federal income tax.
Fees generated by Network Administrators, Inc. ("Network"), a wholly
owned subsidiary of the Company, were $722,000 in 1996 and $435,000 in 1997.
Network no longer functions as a third-party administrator and did not
generate any fee income in 1998.
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 are periodically reviewed by independent professional
actuaries. See "BUSINESS - Reserves."
The percentage of losses and loss adjustment expenses to net premiums
earned ("loss ratio") was 59.8%, 60.7% and 68.3% in 1996, 1997 and 1998,
respectively. The increase in the 1998 loss ratio was primarily the result
of additional loss development from prior accident years which was recognized
in 1998, and an increase in storm-related losses. The prior year loss
development recognized in 1998 totaled $5.2 million and increased the loss
ratio by 7.3 percentage points. Storm-related losses from wind and hail
totaled $1.5 million in 1998 compared to $459,000 in 1997, and increased the
loss ratio for 1998 by 2.2 percentage points.
<PAGE>
PAGE 23
POLICY ACQUISITION COSTS
Policy acquisition costs consist of costs associated with the acquisition
of new and renewal business and generally include direct costs such as premium
taxes, commissions to agents and ceding companies and premium-related
assessments and indirect costs such as salaries and expenses of personnel who
perform and support underwriting activities. NAICO also receives ceding
commissions from certain of the reinsurers who assume premiums from NAICO
under certain reinsurance contracts and the ceding commissions are accounted
for as a reduction of policy acquisition costs. Direct policy acquisition
costs and ceding commissions are deferred and amortized over the terms of the
policies. Recoverability of such deferred costs is dependent on the related
unearned premiums on the policies being more than expected claim losses.
The following table sets forth the Company's policy acquisition costs
for each of the three years ended December 31, 1996, 1997 and 1998:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1996 1997 1998
---------- ---------- ----------
(In thousands)
<S> <C> <C> <C>
Commissions expense.........................$ 16,489 $ 15,860 $ 15,478
Other premium related assessments........... 1,258 744 928
Premium taxes............................... 2,705 3,400 3,144
Excise taxes................................ 109 153 161
Dividends to policyholders.................. 454 1,155 242
Other expense............................... 365 146 151
---------- ---------- ----------
Total direct expenses....................... 21,380 21,458 20,104
Indirect underwriting expenses.............. 14,831 13,464 13,858
Commissions received from reinsurers........ (2,895) (6,458) (19,860)
Adjustment for deferred acquisition costs... (1,193) (319) 2,931
---------- ---------- ----------
Net policy acquisition costs................$ 32,123 $ 28,145 $ 17,033
========== ========== ==========
</TABLE>
Total gross direct and indirect expenses as a percentage of direct
written and assumed premiums were 33.5%, 28.4% and 25.3% in 1996, 1997 and
1998, respectively. For these periods, commission expense as a percentage
of gross written and assumed premiums was 15.3%, 12.9% and 11.5%. The
commission rate for a 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, which increased the percentage
of net policy acquisition costs to net premiums earned by 3.1 percentage
points. In 1998, the commission rate for a portion of the surety bond
program was lowered due to an increase in the expected loss ratio which
reduced the percentage of net policy acquisition costs to net premiums
earned by 1.6 percentage points. In addition, the 1998 commission rate
declined due to the lower proportion of surety bond direct written and
assumed premiums to total direct written and assumed premiums. Surety
bonds have historically had a higher commission rate than the Company's
other lines of business.
Indirect underwriting expenses were 13.7%, 10.9% and 10.3% of total
direct written and assumed premiums in 1996, 1997 and 1998, 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 approximately $1.5 million
in indirect underwriting expenses related to the termination of an
arrangement with a surety bond underwriting manager and settlement of
associated litigation, 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 received commissions totaling
approximately $1.9 million and $909,000 during 1997 and 1998, respectively,
under this quota-share reinsurance arrangement. During 1998, NAICO
received commissions from reinsurers totaling approximately $13.8 million
related to the purchase of additional reinsurance under its workers
compensation and casualty reinsurance programs. See "Purchase of
Additional Reinsurance."
The Company incurred approximately $2.1 million, $527,000 and $50,000
in indirect underwriting expenses for uncollectible ceded reinsurance in
1996, 1997 and 1998, respectively. The 1996 amount includes an arbitration
award which was made in favor of NAICO against certain reinsurers for $1.1
million less than had been recorded. NAICO reduced its reinsurance
recoverables accordingly.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were 13.1%, 11.0% and 9.9% of gross
premiums earned and commissions, fees and other income in 1996, 1997 and
1998, 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. General and administrative expenses decreased 6.6% in 1997, due
primarily to $441,000 in litigation-related expenses related to the
termination of an agreement with a former underwriting manager and $527,000
in litigation-related expenses related to the reinsurance arbitration
discussed previously which were incurred in 1996. General and administrative
expenses decreased 3.1% in 1998, due primarily to a reduction in costs
attributable to Network. Network ceased functioning as a third party
administrator during 1997.
<PAGE>
PAGE 24
In 1998, the Company adopted a stock option and stock grant plan for
certain non-employee directors of the Company. Compensation expense related
to the plan in the amount of $272,000 is included in general and
administrative expenses in 1998. Excluding the expense related to the
plan, general and administrative expenses declined $678,000 or 5.2% in
1998 compared to 1997.
INTEREST EXPENSE
Interest expense increased 217% in 1997 and increased 102% in 1998, due
primarily to increased levels of bank debt. See "Liquidity and Capital
Resources."
LITIGATION EXPENSES
Litigation expenses reflect expenses related to the ongoing legal
proceedings involving the CenTra Group. Litigation expenses were a credit of
approximately $2.7 million in 1998 compared to expense of approximately $4.8
million in 1997, and were a credit of $108,000 in 1996. During the second
quarter of 1998, the United States District Court in Oklahoma City, Oklahoma
(the "Oklahoma Federal Court") denied the CenTra Group's request for costs
and attorney fees. Accordingly, the Company reduced the previous first
quarter of 1997 net charge for litigation matters by approximately $3.8
million in 1998.
The 1997 expense included a net charge totaling approximately $1.4
million ($1.6 million including provision for federal income tax) for the
litigation matters related to the CenTra Group. In addition, significant
litigation expenses were incurred in 1997 due to the trial which began on
February 13, 1997. The net charge has been reduced by an estimated recovery
of $2.7 million from the Company's directors and officers liability insurer
for costs associated with the defense and litigation of these matters. The
Company 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.
In 1996, the Company recorded a $982,000 estimated recovery of costs
from it 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.
See "CenTra Litigation" and Note 11 to Consolidated Financial
Statements.
NET INCOME (LOSS)
As a result of the factors described above, the Company reported net
income of $3,442,000 in 1998 compared to a net loss of $1,065,000 in 1997
and net income of $972,000 in 1996. Excluding the effects of the litigation
expenses related to legal proceedings involving the CenTra Group, net income
would have been $591,000 in 1998 compared to approximately $3.4 million in
1997.
Net income for 1996 was 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 which were reflected in general and administrative expenses 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 which were
reflected in general and administrative expenses in 1996.
In 1996, the Company also 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.
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 the 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.
<PAGE>
PAGE 25
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 income tax as a separate
component of shareholders' equity until realized.
In 1997, the Company provided $3.9 million in cash from operations.
During 1998, the Company used $8.8 million in cash from operations due
primarily to the purchase of additional reinsurance described previously. To
augment maturities and reposition their portfolios, CIB and NAICO chose to
liquidate certain fixed maturity securities that were available for sale
prior to their maturities.
Cash flows from investing activities were primarily the result of normal
purchases and sales of investment securities, and in 1997 NAICO sold the
common stock of Century Business Services, Inc. for a total of approximately
$2.5 million. The Century Business Services common stock was received as a
part of NAICO's 1996 settlement with a former underwriting manager. Net
realized investment gains before income taxes in 1997 and 1998 were $764,000
and $1,163,000, respectively, from the sale of investments. In addition, in
1998, CIB and NAICO received proceeds of $12.8 million and $36.2 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 4.6 years and 4.0 years at December 31, 1997 and 1998,
respectively.
CIB 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. CIB 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. At December 31, 1998, the
total amount of cash and investments restricted for CIB and NAICO as a
result of these arrangements was $25.3 million and $8.2 million, respectively.
Cash flows from financing activities were primarily the result of bank
borrowings and repayments. During 1996, Chandler USA borrowed $4.5 million
in bank debt for a three-year term. During the fourth quarter of 1997, the
related loan agreement was amended to provide for additional borrowings up to
$8.5 million and to revise the term to five years with interest payable at a
floating rate equal to 1% over the prime rate published in the Wall Street
Journal, which was 7.75% at December 31, 1998. During March 1998, Chandler
USA borrowed an additional $6.2 million on the note and the proceeds were
used to repay amounts due to CIB. The outstanding balance of the note was
$7.4 million at December 31, 1998. The funds received by CIB may be used
to discharge litigation judgments. The bank note is collateralized by
shares of NAICO stock owned by Chandler USA.
In February 1998, Chandler USA entered into a five-year loan agreement
with a bank having a principal amount of $2.3 million and an interest rate
of 7.75%. In September 1998, the interest rate was reduced to 7.5%.
Monthly payments are approximately $46,000 including principal and interest.
The outstanding balance of the note was $1.9 million at December 31, 1998.
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.
In April 1998, CIM acquired 69,858 shares of the Company's common stock
from an agent for approximately $524,000. These shares had previously been
pledged to NAICO to secure certain obligations resulting from insurance
business produced by another agent.
See "BUSINESS - Recent Debenture Offering."
CENTRA LITIGATION
In 1992, the Company became involved in certain legal proceedings
beyond the ordinary course of business. Note 11 to Consolidated Financial
Statements describes the extensive CenTra litigation related to the Company
and its affiliates and the CenTra Group.
The Company has incurred approximately $2.5 million, $2.1 million, $1.9
million, $1.1 million, $857,000, $7.5 million and a credit of $2.7 million
in costs attributable to these legal proceedings during 1992, 1993, 1994,
1995, 1996, 1997 and 1998 respectively, before recoveries from the
Company's directors and officers liability 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. During the
second quarter of 1998 the Oklahoma Federal Court denied the CenTra Group's
request for costs and attorney fees. Accordingly, the Company reduced the
previous 1997 net charge for litigation matters by $3.8 million in 1998.
As a result of various events in 1995, the Company recorded an $818,000
estimated recovery of costs from its directors and officers liability
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 liability 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.
<PAGE>
PAGE 26
While the Company believes that it is likely that the Company and its
affiliates will ultimately prevail as to all material claims asserted in
the CenTra litigation, should the CenTra litigation be modified, reversed or
decided adversely to the Company, such event could have a material adverse
effect on the Company.
YEAR 2000 READINESS DISCLOSURES
Computer software, hardware, microprocessor chips and other computer
equipment use two digits to identify a particular year, and therefore may not
recognize the number "00" or may recognize it as a year prior to 1999.
Unless computer equipment and software programs are modified to correct these
data recognition problems (the "Year 2000 Problems"), errors could result.
These errors could cause damage to personal property and disrupt business
practices and functions. In addition to potential problems from computer
systems, potential problems could arise from equipment with embedded chips,
such as vaults, elevators, aircraft and other systems not generally
classified as information technology systems.
The Company is heavily dependent upon complex information technology
computer systems for the Company's operations. The Company has taken action
to attempt to identify the nature and extent of the work required to assess
and remediate Year 2000 Problems with respect to its systems, products and
infrastructures (including non-information technology systems, none of which
are considered critical to operations). The Company 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 as
currently planned is substantially complete at this time. The Company
estimates that it has spent $350,000 updating these systems to address Year
2000 Problems, and such costs were expensed as they were incurred,
primarily in 1996 and 1997.
During the fourth quarter of 1998, the Company retained an independent
consultant to prepare a plan for testing its information technology systems.
In late 1998, the Company determined that the testing would be performed by
Company employees, and this testing is anticipated to be completed during
the first half of 1999. During the fourth quarter of 1998, the Company
incurred approximately $150,000 in additional expenses to evaluate its
information systems and in preparation of plans to test the Company's
information systems.
Evaluation and testing of the Company's efforts to address Year 2000
Problems is ongoing. The Company estimates the additional cost of the
testing to be approximately $115,000 which includes the use of internal
employees, cost of external software to enhance testing efforts and
computer rental costs. These costs will be expensed during 1999 as incurred.
This estimate is based on currently available information. The Company
continues to evaluate the estimated costs associated with future efforts on
actual experience. These efforts may involve additional costs. The Company
is also formulating and studying contingency plans with completion expected
by mid-1999.
The Company believes, based on the information currently available, that
the most reasonably likely worst case scenarios resulting from Year 2000
Problems include:
- Legal risks arising from failure of NAICO or L&W to provide
contracted services, deal with claims on a timely basis, provide
pertinent data to those dependent upon the data and similar
risks;
- Increased operational costs due to manual processing, data
corruption or disaster recovery;
- Inability to bill or invoice;
- Lost revenue resulting from the inability to render accurate
billings and from the inability to efficiently market insurance
products;
- Increased legal and accounting expenses;
- Fines and associated expenses resulting from inability to comply
with regulatory requirements; and
- Failure of management controls.
Any previously mentioned Year 2000 Problems could have a material adverse
effect on the Company, including the financial condition of the Company's
subsidiaries and their ability to pay dividends or other payments to the
Company and its subsidiaries.
The Company cannot predict the adverse impact, if any, of Year 2000
Problems upon its agents, reinsurers and others with whom it does business.
It is possible that the credit or operating 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. However, the
Company does not have control over these third parties and, as a result, it
cannot currently determine to what extent future operating results may be
adversely affected by the failure of these third parties to successfully
address their Year 2000 Problems. However, the Company is developing plans
to attempt to minimize identified third-party exposures.
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 and NAICO's liability to its insureds.
The Company believes that the coverages NAICO provides do not extend to the
types of losses which are most likely to occur as a result of Year 2000
Problems, and NAICO has made no provisions for loss reserves based on
potential Year 2000 Problems. NAICO expects to utilize coverage exclusion
endorsements based on the individual underwriting of commercial accounts,
and it has adopted endorsements to its policies based on forms provided and
filed for approval with various regulatory authorities by Insurance Services
Office, Inc., an insurance services company which provides regulatory
research and filing support to insurance companies. Use of these special
endorsements is governed by the law and regulatory policies of states in
which NAICO is authorized to do business.
<PAGE>
PAGE 27
It is possible that future court interpretations of policy language based
on specific facts, or legislation mandating coverage, could result in coverage
for losses attributable to Year 2000 Problems. Such decisions or legislation
could have a material adverse impact on the Company. It is also possible
that NAICO may incur expenses defending claims for which it is ultimately
determined there is no insurance coverage.
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. During
1998, the IRS conducted an examination of the 1995 U.S. Federal income tax
return of CIB. The IRS completed the examination in the third quarter of
1998, and there were no proposed adjustments to tax liabilities.
RECENTLY ADOPTED ACCOUNTING STANDARDS
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 separate
financial statement or as a component of the consolidated statements of
operations or the consolidated statements of shareholders' equity and display
the accumulated balance of other comprehensive income separately in the
shareholders' equity section of the consolidated balance sheets. The Company
adopted SFAS No. 130 on January 1, 1998 as required. The adoption of SFAS
No. 130 resulted in revised and additional disclosures but had no effect on
the financial position, results of operations or liquidity of the Company.
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 adopted SFAS No. 131 on January 1, 1998 as required.
ACCOUNTING STANDARD ISSUED BUT NOT YET ADOPTED
In June 1998, the FASB issued SFAS No. 133, ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES. SFAS No. 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, (collectively referred to as
derivatives) and for hedging activities. It requires that the Company
recognize all derivatives as either assets or liabilities in the statement
of financial condition and measure those instruments at fair value. The
accounting for changes in the fair value of a derivative (that is, gains and
losses) depends on the intended use of the derivative and the resulting
designation. The Company will adopt SFAS No. 133 on January 1, 2000 as
required. Management of the Company believes that adoption of SFAS No. 133
will not have a material impact on the Company's consolidated financial
condition or results of operations.
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; (vii) the ability of the Company and its third
party providers, agents and reinsurers to adequately address Year 2000
Problems; and (viii) other factors such as the ongoing litigation matters
involving a significant concentration of ownership of common stock.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's consolidated balance sheets include a certain amount of
assets and liabilities whose fair values are subject to market risk. Due to
the Company's significant investment in fixed-maturity investments, interest
rate risk represents the largest market risk factor affecting the Company's
consolidated financial position. Increases and decreases in prevailing
interest rates generally translate into decreases and increases in fair
values of those instruments. Additionally, fair values of interest rate
sensitive instruments may be affected by the credit worthiness of the issuer,
prepayment options, relative values of alternative investments, liquidity of
the instrument and other general market conditions.
As of December 31,1998, substantially all of the investments of CIB
and NAICO were in fixed-maturity investments (rated Aa3 or AA- or better
by Moody's Investors Service, Inc. or Standard & Poor's, respectively),
interest-bearing money market accounts and a collateralized repurchase
agreement. The Company does not hold any investments classified as trading
account assets or derivative financial instruments.
<PAGE>
PAGE 28
The table below summarizes the estimated effects of hypothetical
increases and decreases in interest rates on the Company's fixed-maturity
investment portfolio. It is assumed that the changes occur immediately
and uniformly, with no effect given to any steps that management might take
to counteract that change. The hypothetical changes in market interest rates
reflect what could be deemed best and worst case scenarios. The fair values
shown in the following table are based on contractual maturities. Significant
variations in market interest rates could produce changes in the timing of
repayments due to prepayment options available. The fair value of such
instruments could be affected and, therefore, actual results might differ from
those reflected in the following table:
<TABLE>
<CAPTION>
Estimated
Hypothetical fair value after
change in hypothetical
Fair value at interest rate change in
December 31, 1998 (bp=basis points) interest rate
----------------- ----------------- ----------------
(Dollars in thousands)
<S> <C> <C> <C>
Fixed-maturity
investments (1).........$ 97,074 100 bp increase.. $ 93,731
200 bp increase.. 90,581
100 bp decrease.. 100,627
200 bp decrease.. 104,406
- ---------------------
<FN>
(1) Excluding short-term investments with a fair value of $13.3 million.
</TABLE>
The table above illustrates, for example, that an instantaneous 200 basis
point increase in market interest rates at December 31, 1998 would reduce the
estimated fair value of the Company's fixed-maturity investments by
approximately $6.5 million at that date.
In addition to the Company's fixed-maturity investments, the Company also
has notes payable that are subject to interest rate risk. The table below
presents the carrying value of the instruments (which approximates fair
value), as well as the average interest rate and the principal payments
categorized by expected maturity dates.
<TABLE>
<CAPTION>
Notes payable- Notes payable-
fixed rate (1) variable rate (2)
-------------- -----------------
(In thousands)
<S> <C> <C>
1999........... $ 500 $ 1,549
2000........... 458 1,690
2001........... 495 1,848
2002........... 533 2,375
2003........... 27 -
-------------- -----------------
Total.......... $ 2,013 $ 7,462
============== =================
- ---------------------------
<FN>
(1) Average interest rate is 7.5%.
(2) Interest is payable at a floating rate equal to 1% over the prime
rate published in the Wall Street Journal, which was 7.75% at
December 31, 1998.
</TABLE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Item 14 (a) 1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
<PAGE>
PAGE 29
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 53 Chairman of the Board, Chief Executive
Officer, President, Executive Committee
Chairman, Investment Committee Member and
Director.
Mark T. Paden 42 Executive Vice President, Chief Financial
Officer, Executive Committee Member,
Investment Committee Member and Director.
Brenda B. Watson 58 Executive Vice President, Executive
Committee Member and Director.
Richard L. Evans 52 Vice President and Director.
Steven R. Butler 41 Vice President - Administration.
Mark C. Hart 43 Vice President - Accounting and Treasurer.
Norman E. Harned 58 Director.
James M. Jacoby 64 Audit Committee Member, Option and
Compensation Committee Chairman and
Director.
Ronald W. Lech 69 Director.
Paul A. Maestri 68 Executive Committee Member, Audit Committee
Member, Option and Compensation Committee
Member and Director.
M. J. Moroun 71 Director.
Robert L. Rice 64 Audit Committee Chairman, Executive
Committee Member, Investment Committee
Member, Option and Compensation Committee
Member and Director.
Larry A. Davis 57 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.
MARK T. PADEN has served as Executive Vice President of the Company since
May 1998, was Vice President - Finance of the Company from August 1987
through May 1998 and has been a director since May 1992. Since February
1987 Mr. Paden has been an employee of L&W and/or Chandler USA. In May
1998, Mr. Paden was elected Executive Vice President and Chief Operating
Officer for Chandler USA, NAICO and L&W. Mr. Paden has served as Chief
Financial Officer of NAICO since January 1988 and of L&W since May 1987,
and also served as Vice President - Finance of NAICO from January 1988
through May 1998 and of L&W from May 1987 through May 1998. Mr. Paden has
also been a director of Chandler USA since July 1988, NAICO since November
1992 and L&W since October 1992.
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.
<PAGE>
PAGE 30
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, and is a director and serves as President of CIB. The Company began
handling its own and CIB's 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 CIB, respectively, through March 1990.
MARK C. HART has served as Vice President - Accounting and Treasurer of
the Company since May 1998. Since May 1988, Mr. Hart has been an employee
of NAICO and/or Chandler USA. In May 1998, Mr. Hart was elected Vice
President - Finance and Treasurer of Chandler USA, NAICO and L&W. Mr. Hart
has been a Vice President of Chandler USA since March 1994.
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. where he was a Vice President with the Omaha, Nebraska
office, and is currently employed by Constructor's Bonding & Insurance in
Omaha, Nebraska where he is involved in servicing insurance accounts.
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, NAICO since May 1997 and CIM since May 1998.
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,
L&W since May 1997 and CIM since May 1998.
LARRY A. DAVIS has been a director of the Company since August 1997. Mr.
Davis has also been a director of CIB and CIM Barbados since December 1992.
Since July 1998, Mr. Davis has been Manager of Neweol Investments Limited,
Luxembourg Branch, a Canadian corporation wholly owned by The Loewen Group
of Burnaby, British Columbia, Canada. From September 1996 to July 1998, Mr.
Davis was Vice President with Loewen Financial Corporation, a Barbados
corporation wholly owned by The Loewen Group. From September 1993 to
September 1996, Mr. Davis provided business consulting services and served
as a director for several Barbados corporations. Mr. Davis was Chairman
and Chief Executive Officer of Caribbean Commercial Bank, a Barbados
corporation, from September 1988 to September 1993.
In the civil proceeding CenTra, Inc. v. Chandler Insurance Company, Ltd.,
et. al, Case No. CIV-92-1301-M, in the U.S. District Court for the Western
District of Oklahoma, judgment was entered in favor of CenTra and against
Messrs. LaGere, Paden, Evans, Rice, Ms. Watson and two former directors in the
amount of $1.00 each, finding a violation of Section 10(b) of the Securities
Exchange Act of 1934 and a violation of Section 11(a) of the Securities Act of
1933 based upon a failure by the Company and certain of its officers and
directors to disclose the applicability of the Nebraska Insurance Holding
Company Act to purchasers of stock of the Company in a public offering. The
judgments are currently being appealed. See Note 11 to Consolidated Financial
Statements.
COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934
Based solely upon a review of Forms 3, 4 and 5, any amendments thereto
furnished to the Company pursuant to the rules of the Securities and Exchange
Commission, or written representations from certain reporting persons
presented to the Company, all such reports required to be filed by reporting
persons have been filed in a timely fashion during the fiscal year ended
December 31, 1998.
<PAGE>
PAGE 31
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth the compensation paid or to be paid by the
Company or any of its subsidiaries as well as certain other compensation paid
or accrued, during the years indicated, to the Chairman and Chief Executive
Officer and the four other highest paid executive officers of the Company (the
"Named Executives") for such period in all capacities in which they served.
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION (1)
------------------------------------------------
OTHER ANNUAL ALL OTHER
SALARY BONUS COMPENSATION COMPENSATION
NAME AND PRINCIPAL POSITIONS YEAR ($) ($)(2) ($)(3) ($)(4)
- ---------------------------------------- -------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
W. Brent LaGere 1998 $ 397,361 $ - N/A $ 36,596
Chairman of the Board, CEO and 1997 389,340 - N/A 37,471
President of Chandler USA, 1996 378,610 - N/A 40,148
NAICO and L&W
Mark T. Paden 1998 209,300 - N/A 4,900
Executive Vice President, COO & 1997 178,637 - N/A 4,975
CFO of Chandler USA, NAICO and L&W 1996 173,188 - N/A 12,752
Brenda B. Watson 1998 221,607 - N/A 8,100
Executive Vice President of NAICO 1997 216,882 - N/A 8,475
and L&W 1996 211,182 - N/A 15,552
Richard L. Evans 1998 218,190 - N/A 6,200
Vice President - Claims of Chandler 1997 211,873 - N/A 6,275
USA, NAICO and L&W 1996 205,896 - N/A 13,752
Steven R. Butler 1998 133,252 16,272 N/A -
President of CIM and CIM Barbados 1997 127,514 12,850 N/A -
1996 122,610 14,554 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) All Named Executives are eligible to participate in bonus plans based
upon premium production and/or profitability.
(3) The Company provides various perquisites to certain employees including
the Named Executives. In each case, the value of the perquisites
provided to each Named Executive did not exceed ten percent of such
Named Executive's annual salary and bonus.
(4) The amounts shown under this column represent contributions by the
Company's U.S. subsidiaries to a 401(k) plan ($11,552 for each of the
Named Executives in 1996, $3,475 in 1997 and $3,600 in 1998), 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 ($34,500, $24,300 and $23,400 in 1996, 1997 and 1998,
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 Named Executive cancels and surrenders the policy.
</TABLE>
OPTIONS EXERCISED AND HOLDINGS
No options were exercised by the Named Executives during 1998 and there
were no unexercised options held by the Named Executives as of December 31,
1998.
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. During 1998,
Messrs. Maestri, Jacoby and Davis received total director compensation of
$38,500, $35,750 and $33,000, respectively, including compensation for time
spent in connection with certain litigation. See Note 11 to Consolidated
Financial Statements.
During the second quarter of 1998, the Company's directors approved the
Directors' Stock Option and Stock Grant Plan (the "Directors' Plan"). The
Directors' Plan provides that the non-employee directors of the Company, other
than Norman Harned, Ronald Lech and M.J. Moroun, are eligible for grants of
stock options and stock grants in accordance with the terms of the Directors'
Plan. Options and stock grants may not be granted under the plan for more
than 260,000 shares of common stock of the Company, but this number may be
adjusted to reflect, if deemed appropriate by the board of directors, any
stock dividend, stock split, share combination, recapitalization or the like,
of or by the Company. The exercise price of the stock options shall generally
be equal to the average closing price of common stock of the Company for the
30 calendar days preceding the date the options are granted. The option
period begins on the effective date of the option grant and terminates on the
tenth anniversary of that date.
<PAGE>
PAGE 32
The aggregate number of shares of stock awarded to an eligible director
as a stock grant shall total 20,000 shares of common stock of the Company.
The award shall be divided into two equal installments. The first installment
of 10,000 shares shall automatically be awarded as of the first regular board
meeting after an eligible director completes ten continuous years of service
on the board. The second installment of 10,000 shares will automatically be
awarded as of the first anniversary of the initial stock grant, regardless of
whether the director is still a member of the board. During the second
quarter of 1998, a total of 40,000 shares valued at $250,000 were awarded to
two directors, and this amount is included in general and administrative
expenses in the Company's consolidated statements of operations. During the
third quarter of 1998, the Company issued 20,000 of the 40,000 shares to the
two directors as required under the plan from the Company's stock held by
subsidiary. The difference between the average cost of the shares issued and
the share price at the date of the stock grant was credited to paid-in
surplus.
Each eligible director shall automatically be granted options to purchase
1,500 shares of common stock of the Company as of the first regular board
meeting in each year the director serves on the board. Each eligible director
shall also automatically be granted options to purchase 30,000 shares of
common stock of the Company effective as of the first regular board meeting
after the director completes ten continuous years of service on the board.
During the second quarter of 1998, options for 66,000 shares were awarded with
an exercise price of $5.92 per share, which resulted in approximately $22,000
of compensation expense which is included in general and administrative
expenses in the Company's consolidated statements of operations. The options
require shareholder approval prior to being exercised.
EMPLOYMENT AGREEMENTS
Chandler USA has employment agreements with W. Brent LaGere, Chairman of
the Board and Chief Executive Officer of the Company and its subsidiaries and
with Ernie B. Pierce, an executive officer of L&W. Under certain limited
circumstances, such officers could receive base salaries subsequent to early
termination of their employment subject to certain continued obligations to
Chandler USA. The agreements contain self-renewing terms of five years that
terminate upon the employee attaining age 70. Messrs. LaGere and Pierce are
eligible to participate in certain incentive bonus plans offered by Chandler
USA and its subsidiaries.
Chandler USA has an employment agreement with Brenda B. Watson, a
director and executive officer of the Company and L&W, and an executive
officer of NAICO. The agreement terminates on January 1, 2004. Under
certain limited circumstances, Ms. Watson could receive base salary subsequent
to an early termination of her employment subject to certain continued
obligations to Chandler USA. Ms. Watson is eligible to participate in
certain incentive bonus plans offered by Chandler USA and its subsidiaries.
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 it 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 based on an annual rate of $323,291 under the Employment
Agreement through October 2000 at which time he reaches age 70.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table lists the directors and executive officers of the
Company and provides information on their ownership of the Company's common
shares at February 28, 1999:
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP
---------------------------
NUMBER OF
NAME OF DIRECTOR OR EXECUTIVE OFFICER SHARES (1) PERCENT (2)
- -------------------------------------------------- ------------- -----------
<S> <C> <C>
W. Brent LaGere................................... 471,465 (3) 7.4%
Brenda B. Watson.................................. 53,566 *
Richard L. Evans.................................. 53,014 *
Norman E. Harned.................................. 3,133,900 (5) 49.0%
Paul A. Maestri................................... 20,000 (4) *
M.J. Moroun....................................... 3,133,900 (5) 49.0%
James M. Jacoby................................... - (6) -
Robert L. Rice.................................... 20,000 (4) *
Mark T. Paden..................................... 26,310 *
Ronald W. Lech.................................... 3,133,900 (5) 49.0%
Larry A. Davis.................................... - (6) -
Mark C. Hart...................................... 2,515 *
Steven R. Butler.................................. 1,000 *
All directors and officers as a group (13 persons) 3,781,770 (7) 58.9%
- --------------------------------------------------
<FN>
* Less than 1%
(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 which have been awarded but not issued
under the Directors' Plan 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 6,397,233 shares of common stock outstanding including 1,660,125 common
shares rescinded through litigation but excluding 544,475 common shares
owned by a subsidiary of the Company which are eligible to vote. The
percentage for "all directors and executive officers as a group" is
computed based on 6,417,233 shares of common stock which include the
shares discussed in footnote (7) below. 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.
<PAGE>
PAGE 33
(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. The business address of Mr. LaGere is 1010
Manvel Avenue, Chandler, Oklahoma,74834.
(4) Includes: (i) 10,000 common shares issued during 1998 pursuant to the
Directors' Plan and (ii) 10,000 common shares which have been awarded and
will be issued during 1999. These totals do not include 31,500 common
shares issuable under outstanding options the exercisability of which is
subject to approval by the Company's shareholders.
(5) 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) 200
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.
(6) These totals do not include 1,500 shares issuable under outstanding options
the exercisability of which is subject to approval by the Company's
shareholders.
(7) Includes 20,000 common shares which have been awarded and will be issued
during 1999 pursuant to the Directors' Plan.
</TABLE>
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, 1999. 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, Lech and Harned,
Agnes A. Moroun and Matthew T. Moroun)
12225 Stephens Road, Warren, Michigan 48089..... 3,133,900 (3) 49.0%
Benjamin T. Walkingstick
1001 Manvel Avenue, Chandler, Oklahoma 74834.... 401,029 (4) 6.3%
Marvel List, Trustee of the W. Brent LaGere
Irrevocable Trust
420 Bennett Boulevard,
Chandler, Oklahoma 74834........................ 398,077 6.2%
- --------------------------------------------------
<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 which have been awarded but not issued under
the Directors' Plan 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 6,397,233 shares
of common stock outstanding including 1,660,125 common shares rescinded
through litigation but excluding 544,475 common shares owned by a
subsidiary of the Company which are eligible to vote.
(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 contracted to acquire subject to regulatory
approval and was calculated based on total outstanding shares of 7,509,058.
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) 200 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.
The business address of CenTra, Can-Am, and Messrs. 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.
(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.
</TABLE>
<PAGE>
PAGE 34
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 ("Nebraska Court") 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 Note 11 to
Consolidated Financial Statements.
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
Note 11 to Consolidated Financial Statements 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
("Nebraska Court") 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 Nebraska Court's divestiture
order. On July 29, 1998, the U.S. Court of Appeals for the Eighth Circuit
affirmed the Nebraska Court's order that the CenTra Group be divested of
ownership or control of its shares. This ruling allows the Nebraska Court to
consider divestiture plans which may be submitted by NAICO, the Department and
the CenTra Group. All shares owned or controlled by the CenTra Group remain
in the Nebraska Court's possession pending further orders by that court. On
October 28, 1998, the CenTra Group filed pleadings in the Nebraska Court
requesting the appointment of a special master to supervise the divestiture
and an independent trustee to hold and vote the Company's shares owned by the
CenTra Group in accordance with specific instructions pending the final
implementation of a divestiture plan. NAICO objected to the CenTra proposal
on November 25, 1998 and responded with a divestiture plan of its own (the
"NAICO Plan"). The Nebraska Court rejected the CenTra proposal and CenTra
responded to the NAICO Plan on December 28, 1998. The Nebraska Court has made
no ruling on the NAICO Plan. NAICO's plan includes a proposal whereby the
Company would acquire and cancel the shares of Chandler Stock owned or
acquired by the CenTra Group. The NAICO Plan has been approved by the
Company's executive committee of the Board of Directors. The Department
generally supports the NAICO Plan. Until CenTra can overcome these
impediments, it cannot take control of the Company.
<PAGE>
PAGE 35
Despite these impediments, CenTra continues its efforts to take control
of the Company. 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
In June and November 1998, W. Brent LaGere purchased, on behalf of and
for the benefit of the Chandler (U.S.A.), Inc. 401(k) Thrift Plan (the "Plan")
52,000 and 80,000 shares, respectively, of the Company's common stock. On
November 19, 1998, the Plan acquired these and other shares of the Company's
common stock at no profit to Mr. LaGere.
Chandler USA leases a rural property from Davenport Farms, Inc.
("Davenport Farms"), a corporation owned by Messrs. LaGere, Evans, Paden and
Pierce. Chandler USA has placed three mobile homes on the property, drilled
a water well connected to the mobile homes and made other smaller improvements
to the property. Its personnel maintains these improvements. These mobile
homes and the property provide hunting, fishing, lodging, dining and other
outdoor recreational activities for the entertainment of customers and
business associates of Chandler USA and/or its subsidiaries. Chandler USA
pays no rent to Davenport Farms but reimburses it for one-half of the
utilities and for hunting supplies. Chandler USA has also agreed to
indemnify Davenport Farms for claims arising out of its use of the property.
Chandler USA retains the right to remove all structures located upon the
property when the lease terminates. In 1996, 1997 and 1998, Chandler USA
incurred approximately $184,000, $159,000 and $217,000, respectively, in
expenses associated with this property.
On September 18, 1997, Benjamin T. 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 by either party 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. Commissions paid to Mr. Walkingstick under this arrangement were
$10,832 and $10,603 during 1997 and 1998, respectively.
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 $2.2 million as of December 31, 1998. 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 liability insurer. As a
result of various events in 1995, the Company recorded an $818,000 estimated
recovery of costs from its directors and officers liability 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 liability 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 liability insurer, no provision has been made in the
accompanying consolidated financial statements related to the advancement of
litigation expenses to certain defendants. The special litigation committee's
of the Company and Chandler USA were delegated the authority of the board's of
directors to deal with all issues arising from the Oklahoma litigation
including the issue of officer and director indemnification.
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.
<PAGE>
PAGE 36
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, 1997 and 1998, and
the related consolidated statements of operations, comprehensive
income, shareholders' equity and cash flows for each of the three
years in the period ended December 31, 1998, together with the
related notes thereto and the report of Deloitte & Touche,
independent auditors on such financial statements as of December
31, 1998 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)
10.1 Non-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)
10.4 Directors' Stock Option and Stock Grant Plan. (6)
21.1 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.
(6) Previously filed as an exhibit to registrant's Quarterly
Report on Form 10-Q for the quarterly period ended June 30,
1998 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 December 1, 1998
responding to Item 5 of Form 8-K.
<PAGE>
PAGE 37
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 26, 1999 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 26, 1999 /s/ W. Brent LaGere
----------------------------------------
W. Brent LaGere, Chairman of the Board,
Chief Executive Officer, President and
Director (Principal Executive Officer)
Date: March 26, 1999 /s/ Mark T. Paden
----------------------------------------
Mark T. Paden, Executive Vice President,
Chief Financial Officer, and Director
(Principal Financial Officer)
Date: March 26, 1999 /s/ Mark C. Hart
----------------------------------------
Mark C. Hart, Vice President -
Accounting & Treasurer (Principal
Accounting Officer)
Date: March 26, 1999 /s/ Brenda B. Watson
----------------------------------------
Brenda B. Watson, Executive Vice
President and Director
Date: March 26, 1999 /s/ Richard L. Evans
----------------------------------------
Richard L. Evans, Vice President -
Claims and Director
Date: March 26, 1999 /s/ James M. Jacoby
----------------------------------------
James M. Jacoby, Director
<PAGE>
PAGE 38
Date: March 26, 1999 /s/ Robert L. Rice
----------------------------------------
Robert L. Rice, Director
Date: March 26, 1999 /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 26, 1999 /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, 1997 and 1998................................ F-2
Consolidated Statements of Operations for the years ended
December 31, 1996, 1997 and 1998.......................... F-3
Consolidated Statements of Comprehensive Income for the
years ended December 31, 1996, 1997 and 1998.............. F-4
Consolidated Statements of Cash Flows for the years ended
December 31, 1996, 1997 and 1998.......................... F-5
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 1996, 1997 and 1998.............. F-6
Notes to Consolidated Financial Statements..................... F-7 through F-29
Independent Auditors' Report on Consolidated Financial
Statements and Financial Statement Schedules.............. F-30
SCHEDULES
I Summary of Investments - Other Than Investments
in Related Parties................................... F-31
II Condensed Financial Information of Registrant.............F-32 through F-34
III Supplementary Insurance Information....................... F-35
IV Reinsurance............................................... F-36
V Valuation and Qualifying Accounts......................... F-37
VI Supplemental Information (for property-casualty
insurance underwriters).............................. F-38
<PAGE>
PAGE F-2
CHANDLER INSURANCE COMPANY, LTD.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands except share amounts)
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
ASSETS 1997 1998
---------- ----------
<S> <C> <C>
Investments
Fixed maturities available for sale,
at fair value......................................$ 111,718 $ 109,055
Fixed maturities held to maturity, at amortized
cost (fair value $1,330 and $1,332 in
1997 and 1998, respectively)....................... 1,222 1,183
Equity securities available for sale, at fair value... 124 191
---------- ----------
Total investments.................................. 113,064 110,429
Cash and cash equivalents................................ 11,999 10,383
Premiums receivable, less allowance for non-collection
of $115 and $200 at 1997 and 1998, respectively....... 28,079 28,479
Reinsurance recoverable on paid losses, less allowance
for non-collection of $275 at 1997 and 1998........... 3,069 2,760
Reinsurance recoverable on unpaid losses, less allowance
for non-collection of $390 and $330 at 1997
and 1998, respectively................................ 10,876 28,970
Prepaid reinsurance premiums............................. 9,662 22,448
Deferred policy acquisition costs........................ 5,312 2,381
Property and equipment, net.............................. 5,907 8,124
Other assets............................................. 12,893 13,253
Licenses, net............................................ 4,344 4,194
Excess of cost over net assets acquired, net............. 5,252 4,604
Covenants not to compete, net............................ 333 -
---------- ----------
Total assets.............................................$ 210,790 $ 236,025
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Unpaid losses and loss adjustment expenses............$ 74,929 $ 80,909
Unearned premiums..................................... 42,388 50,647
Policyholder deposits................................. 4,830 4,936
Notes payable......................................... 2,796 9,410
Accrued taxes and other payables...................... 6,340 3,869
Premiums payable...................................... 4,554 10,961
Litigation liabilities................................ 16,618 13,228
---------- ----------
Total liabilities........................................ 152,455 173,960
---------- ----------
Commitments and contingencies (Notes 11 and 12)
Shareholders' equity
Common stock, $1.67 par value, 10,000,000 shares
authorized; 6,941,708 shares issued................ 11,593 11,593
Paid-in surplus....................................... 34,942 34,983
Common stock to be issued (20,000 shares)............. - 125
Capital redemption reserve............................ 947 947
Retained earnings..................................... 24,886 28,328
Less: Stock held by subsidiary, at cost (494,617 and
544,475 shares in 1997 and 1998, respectively)..... (2,487) (2,905)
Less: Stock rescinded through litigation
(1,660,125 shares)................................. (11,799) (11,799)
Accumulated other comprehensive income:
Unrealized gain on investments available for
sale, net of deferred income taxes................. 253 793
---------- ----------
Total shareholders' equity............................... 58,335 62,065
---------- ----------
Total liabilities and shareholders' equity...............$ 210,790 $ 236,025
========== ==========
</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,
------------------------------------
1996 1997 1998
---------- ---------- ----------
<S> <C> <C> <C>
Premiums and other revenues
Direct premiums written and assumed......$ 107,943 $ 123,088 $ 134,329
Reinsurance premiums ceded............... (14,228) (26,222) (68,793)
---------- ---------- ----------
Net premiums written and assumed...... 93,715 96,866 65,536
Decrease (increase) in
unearned premiums..................... (4,429) (2,187) 4,528
---------- ---------- ----------
Net premiums earned................... 89,286 94,679 70,064
Interest income, net........................ 7,199 7,253 6,467
Realized investment gains, net.............. 140 764 1,163
Commissions, fees and other income.......... 3,620 2,528 1,952
---------- ---------- ----------
Total premiums and other revenues..... 100,245 105,224 79,646
---------- ---------- ----------
Operating costs and expenses
Losses and loss adjustment expenses...... 53,391 57,512 47,879
Policy acquisition costs................. 32,123 28,145 17,033
General and administrative expenses...... 14,038 13,116 12,710
Interest expense......................... 146 463 936
Litigation expenses, net................. (108) 4,772 (2,707)
---------- ---------- ----------
Total operating costs and expenses.... 99,590 104,008 75,851
---------- ---------- ----------
Income before income taxes.................. 655 1,216 3,795
Federal income tax (provision) benefit
of consolidated U.S. subsidiaries........ 317 (2,281) (353)
---------- ---------- ----------
Net income (loss)...........................$ 972 $ (1,065) $ 3,442
========== ========== ==========
Basic earnings (loss) per common share......$ 0.14 $ (0.16) $ 0.54
Diluted earnings (loss) per common share....$ 0.14 $ (0.16) $ 0.53
Basic weighted average common shares
outstanding.............................. 6,942 6,687 6,429
Diluted weighted average common shares
outstanding.............................. 6,942 6,687 6,438
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
<PAGE>
PAGE F-4
CHANDLER INSURANCE COMPANY, LTD.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1996 1997 1998
---------- ---------- ----------
<S> <C> <C> <C>
Net income (loss)........................... $ 972 $ (1,065) $ 3,442
Other comprehensive income (loss), before
income tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses)
arising during period.............. (2,382) 2,369 1,905
Less: Reclassification adjustment for
gains (losses) included in net
income (loss)......................... (140) (764) (1,163)
---------- ---------- ----------
Other comprehensive income (loss), before
income tax............................... (2,522) 1,605 742
Income tax benefit (provision) related to
items of other comprehensive income
(loss)................................... 647 (466) (202)
---------- ---------- ----------
Other comprehensive income (loss), net of
income tax............................... (1,875) 1,139 540
---------- ---------- ----------
Comprehensive income (loss)................. $ (903) $ 74 $ 3,982
========== ========== ==========
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
<PAGE>
PAGE F-5
CHANDLER INSURANCE COMPANY, LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1996 1997 1998
---------- ---------- ----------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss)........................$ 972 $ (1,065) $ 3,442
Add (deduct):
Adjustments to reconcile net income
(loss) to cash provided by (applied
to) operating activities:
Realized investment gains, net..... (140) (764) (1,163)
Net (gains) losses on sale of
property and equipment.......... (23) 3 (146)
Amortization and depreciation...... 2,292 2,214 2,458
Provision for non-collection
of premiums..................... 1,768 52 152
Provision for non-collection
of reinsurance recoverables..... 2,078 527 50
Earned compensation: non-employee
director stock option and
stock grant plan................ - - 272
Net change in non-cash balances
relating to operating activities:
Premiums receivable................ 2,877 (1,794) (552)
Reinsurance recoverable on
paid losses..................... (1,250) 596 (160)
Reinsurance recoverable on
unpaid losses................... 32,197 3,169 (17,676)
Prepaid reinsurance premiums....... (300) (4,192) (12,786)
Deferred policy acquisition costs.. (1,193) (319) 2,931
Other assets....................... (253) (2,456) (562)
Unpaid losses and loss
adjustment expenses............. (49,155) (4,710) 5,980
Unearned premiums.................. 4,729 6,379 8,259
Policyholder deposits.............. (468) 814 106
Accrued taxes and other payables... 2,108 (1,437) (2,471)
Premiums payable................... (524) 2,106 6,407
Litigation liabilities............. - 4,819 (3,390)
---------- ---------- ----------
Cash provided by (applied to)
operating activities............... (4,285) 3,942 (8,849)
---------- ---------- ----------
INVESTING ACTIVITIES
Fixed maturities available for sale:
Purchases............................. (34,085) (35,001) (71,195)
Sales................................. 16,880 22,232 47,957
Maturities............................ 12,967 12,541 27,413
Fixed maturities held to maturity:
Maturities............................ 4,409 380 100
Equity securities available for sale:
Sales................................. - 2,459 -
Cost of property and equipment
purchased............................. (687) (893) (3,470)
Proceeds from sale of property and
equipment............................. 95 45 337
Other.................................... (20) - -
---------- ---------- ----------
Cash provided by (applied to)
investing activities............... (441) 1,763 1,142
---------- ---------- ----------
FINANCING ACTIVITIES
Cost of common stock purchased
by subsidiary......................... - - (524)
Proceeds from notes payable.............. 4,500 - 8,548
Payments on notes payable................ (409) (1,595) (1,933)
---------- ---------- ----------
Cash provided by (applied to)
financing activities............... 4,091 (1,595) 6,091
---------- ---------- ----------
Increase (decrease) in cash and cash
equivalents.............................. (635) 4,110 (1,616)
Cash and cash equivalents at beginning
of year.................................. 8,524 7,889 11,999
---------- ---------- ----------
Cash and cash equivalents at end of year....$ 7,889 $ 11,999 $ 10,383
========== ========== ==========
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
<PAGE>
PAGE F-6
CHANDLER INSURANCE COMPANY, LTD.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Amounts in thousands except share amounts)
<TABLE>
<CAPTION>
Common Stock Accumulated
stock Capital Stock rescinded other comp- Total
Common Paid-in to be redemption Retained held by through rehensive shareholders'
stock surplus issued reserve earnings subsidiary litigation income equity
--------- --------- -------- ---------- --------- ---------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, January
1, 1996......$ 12,540 $ 36,143 $ - $ - $ 25,926 $ (2,148) $ - $ 89 $ 73,450
Net income....... - - - - 972 - - - 972
Retirement of
stock held by
subsidiary
(567,350
shares)...... (947) (1,201) - 947 (947) 2,148 - - -
Change in
unrealized
loss on
investments
available for
sale, net of
income 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 on
investments
available
for sale, net
of income
tax........... - - - - - - - 1 ,139 1,139
--------- --------- -------- ---------- --------- ---------- ----------- ----------- ------------
Balance, December
31, 1997...... 11,593 34,942 - 947 24,886 (2,487) (11,799) 253 58,335
Net income....... - - - - 3,442 - - - 3,442
Stock acquired
by
subsidiary,
at cost
(69,858
shares)....... - - - - - (524) - - (524)
Stock issued
or to be
issued for
non-employee
director
stock option
and stock
grant plan
(40,000
shares)....... - 41 125 - - 106 - - 272
Change in
unrealized
gain on
investments
available for
sale, net of
income tax.... - - - - - - - 540 540
--------- --------- -------- ---------- --------- ---------- ----------- ----------- ------------
Balance, December
31, 1998......$ 11,593 $ 34,983 $ 125 $ 947 $ 28,328 $ (2,905) $ (11,799) $ 793 $ 62,065
========= ========= ======== ========== ========= ========== =========== =========== ============
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
<PAGE>
PAGE F-7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
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.
Operating revenues, expenses and identifiable assets are primarily
from operations outside the Cayman Islands. The Company's wholly
owned subsidiaries are engaged in various property and casualty
insurance and reinsurance operations. The insurance products offered
by the Company through its subsidiary, National American Insurance
Company, include property and casualty insurance coverage primarily
for businesses in various industries, political subdivisions, surety
bonds for small contractors and group accident and health insurance
in the United States of America ("U.S."). A substantial part of the
business is conducted through individual independent insurance
agencies and underwriting managers, primarily in the Southwest and
Midwest areas of the U.S. One of the Company's subsidiaries,
Chandler Insurance (Barbados), Ltd., principally reinsures risks
underwritten by National American Insurance Company. In addition,
one of the Company's subsidiaries, LaGere and Walkingstick Insurance
Agency, Inc., operates as an independent insurance agency based in
Chandler, Oklahoma, and represents various insurance companies that
provide a variety of property and casualty, life and accident and
health coverages, and acts as a surplus lines broker specializing in
risk management and brokering insurance for commercial enterprises.
The 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. Certain reclassifications of prior years have been made
to conform to the 1998 presentation.
(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. ("CIB") 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 CIB.
- National American Insurance Company ("NAICO") and LaGere and
Walkingstick Insurance Agency, Inc. ("L&W"), wholly owned
subsidiaries of Chandler USA.
All significant intercompany accounts and transactions have been
eliminated in consolidation.
(C) IMPAIRMENT OF LONG-LIVED ASSETS
The Company periodically evaluates the carrying value of
long-lived assets to be held and used when changes in events and
circumstances warrant such a review. The carrying value of a
long-lived asset is considered impaired when the separately
identifiable anticipated undiscounted cash flow from such asset is
less than its carrying value. In that event, a loss is recognized
based on the amount by which the carrying value exceeds the fair
value of the long-lived asset. Fair value is determined primarily
using the anticipated cash flows discounted at a rate commensurate
with the risk involved. Losses on long-lived assets to be disposed
of are determined in a similar manner, except that fair values are
reduced for disposal costs.
(D) REVENUE RECOGNITION
Premiums are generally recognized as earned on a pro rata basis
over the policy period. The portion of premiums that will be earned
in the future are deferred and reported as unearned premiums.
Amounts recorded for ceded reinsurance premiums are reported as
prepaid reinsurance premiums and amortized over the remaining
contract period in proportion to the amount of the insurance
protection provided. Commission revenues are generally recognized
when coverage is effective and premiums are billed.
<PAGE>
PAGE F-8
(E) UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
Losses and loss adjustment expenses are charged to income as
incurred. The reserve for unpaid losses and loss adjustment expenses
represents the accumulation of estimates for reported losses and
includes provisions for losses incurred but not reported based on
data available at this time. The methods of determining such
estimates and establishing resulting reserves are periodically
reviewed and updated, and adjustments therefrom are necessary to
maintain an adequate reserve for unpaid losses and loss adjustment
expenses. As more fully explained in Note 3, such estimates are
management's best estimates of the expected values. The actual
results may vary from these values since the evaluation of losses
is inherently subjective and susceptible to significant changing
factors.
(F) EARNINGS PER COMMON 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. Diluted 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 adjusted for the effect of dilutive potential common shares
calculated using the treasury stock method. Weighted average shares
include 1,660,125 common shares which were rescinded through
litigation during 1997 but are still outstanding, and exclude 494,617
and 544,475 shares held by a subsidiary of the Company at December
31, 1997 and 1998, respectively. The numerator for basic and diluted
earnings per share is equal to the net income (loss) for the
respective period.
The following table sets forth the computation of the
denominator for basic and diluted earnings per share:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1996 1997 1998
-------- -------- --------
(In thousands)
<S> <C> <C> <C>
Denominator for basic earnings (loss) per
common share - weighted average shares...... 6,942 6,687 6,429
Effect of dilutive securities -
non-employee director stock options......... - - 9
-------- -------- --------
Denominator for diluted earnings (loss) per
common share - adjusted weighted average
shares and assumed conversions.............. 6,942 6,687 6,438
======== ======== ========
</TABLE>
(G) DEFERRED POLICY ACQUISITION COSTS
Policy acquisition costs that vary with and are primarily
related to the acquisition of new and renewal business (such as
premium taxes, agent commissions, commissions received from
reinsurers and a portion of other underwriting expenses) are deferred
and amortized over the terms of the policies. 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 interest income in determining if a premium
deficiency exists. Certain policy acquisition costs, such as
policyholder dividends, are expensed directly. NAICO expensed
$454,000, $1.2 million and $242,000 during 1996, 1997 and 1998,
respectively, for dividends to policyholders primarily on
participating workers compensation policies. Gross written premiums
for participating policies were $4.7 million, $3.6 million and $2.3
million in 1996, 1997 and 1998, respectively.
(H) PROPERTY AND EQUIPMENT
Real estate and improvements and other property and equipment
are stated at cost and depreciated using the straight-line method
over their useful lives which range from 3 to 31 years. Property
and equipment consisted of the following at December 31:
<TABLE>
<CAPTION>
1997 1998
---------- ----------
(In thousands)
<S> <C> <C>
Real estate and improvements...........................$ 5,389 $ 5,765
Other property and equipment........................... 7,738 10,257
---------- ----------
13,127 16,022
Accumulated depreciation............................... (7,220) (7,898)
---------- ----------
$ 5,907 $ 8,124
========== ==========
</TABLE>
Depreciation expense was approximately $858,000, $872,000 and
$1,062,000 for 1996, 1997 and 1998, respectively.
<PAGE>
PAGE F-9
(I) INTANGIBLE ASSETS
The cost of insurance licenses acquired is amortized over 40
years using the straight-line method. Covenants not to compete are
amortized by the straight-line method over 10 years. The excess of
cost over net assets acquired is amortized by the straight-line
method over 15-17 years. Intangible assets included the following at
December 31:
<TABLE>
<CAPTION>
1997 1998
---------- ----------
(In thousands)
<S> <C> <C>
Licenses.......................................$ 5,991 $ 5,991
Excess of cost over net assets acquired........ 10,748 10,748
Covenants not to compete....................... 4,000 -
---------- ----------
20,739 16,739
Accumulated amortization....................... (10,810) (7,941)
---------- ----------
$ 9,929 $ 8,798
========== ==========
</TABLE>
(J) POLICYHOLDER DEPOSITS
NAICO requires certain policyholders to pay a deposit at
inception of coverage to secure payment of future premiums and
deductibles on claims incurred. It is expressly agreed between NAICO
and the policyholder that the funds will be used by NAICO only in the
event the policyholder fails to pay any premiums, deductibles or
other charges when due. NAICO has established a liability for these
deposits in an amount equal to that due the policyholders based on
insurance premiums reported as of the balance sheet date.
(K) INVESTMENTS
At the time of purchase, investments in debt securities that 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 income 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. Declines
in the fair value of investment securities below their carrying value
that are other than temporary are recognized in earnings.
(L) 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.
(M) 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.
(N) SUPPLEMENTAL CASH FLOW INFORMATION
Cash payments for interest and income taxes, and noncash
investing activities were as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1996 1997 1998
-------- -------- --------
(In thousands)
<S> <C> <C> <C>
Cash payments during the year for:
Interest...................................... $ 141 $ 818 $ 1,307
Income taxes.................................. 574 1,855 170
Change in unrealized gain (loss) on securities
available for sale............................ $(2,522) 1,605 $ 742
Benefit (provisions) for federal income taxes -
deferred...................................... 647 (466) (202)
-------- -------- --------
Net increase (decrease) in shareholders' equity.. $(1,875) $ 1,139 $ 540
</TABLE>
<PAGE>
PAGE F-10
In January 1997, NAICO received publicly traded common stock
valued at approximately $2.2 million at the settlement date as a
result of settling certain legal disputes with a former underwriting
manager for a portion of the surety bond program.
During 1997, NAICO received shares of common stock in connection
with an unaffiliated entity's conversion to a for-profit corporation.
See Note 2.
During 1997, L&W acquired 494,617 shares of the Company's common
stock from two former agents of NAICO and L&W as payment for debts
owed to NAICO and L&W. L&W transferred those shares during 1997 to
Chandler Insurance Management, Ltd. ("CIM"), a wholly owned
subsidiary of the Company who, in turn assumed debt of L&W to CIB in
the amount of approximately $2.5 million, the fair value of the
shares.
As a result of a jury verdict in April 1997, the Company
recorded the rescission of certain common stock of the Company 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 of the
Company 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 consolidated balance sheets. See Note
11 for additional information.
(O) 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 12, 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.
(P) RECENTLY ADOPTED ACCOUNTING STANDARDS
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 separate financial
statement or as a component of the consolidated statements of
operations or the consolidated statements of shareholders' equity and
display the accumulated balance of other comprehensive income
separately in the shareholders' equity section of the consolidated
balance sheets. The Company adopted SFAS No. 130 on January 1, 1998
as required. The adoption of SFAS No. 130 resulted in revised and
additional disclosures but had no effect on the financial position,
results of operations or liquidity of the Company.
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 adopted SFAS No. 131 on January 1, 1998 as required. See
Note 14.
(Q) ACCOUNTING STANDARD ISSUED BUT NOT YET ADOPTED
In June 1998, the FASB issued SFAS No. 133, ACCOUNTING FOR
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. SFAS No. 133
establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in
other contracts, (collectively referred to as derivatives) and for
hedging activities. It requires that the Company recognize all
derivatives as either assets or liabilities in the statement of
financial condition and measure those instruments at fair value.
The accounting for changes in the fair value of a derivative (that
is, gains and losses) depends on the intended use of the derivative
and the resulting designation. The Company will adopt SFAS No. 133
on January 1, 2000 as required. Management of the Company believes
that adoption of SFAS No. 133 will not have a material impact on the
Company's consolidated financial condition or results of operations.
<PAGE>
PAGE F-11
NOTE 2. INVESTMENTS AND INTEREST INCOME
Net interest income and realized investment gains are summarized
in the following table. These amounts are net of investment
expenses, which are minimal.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1996 1997 1998
-------- -------- --------
(In thousands)
<S> <C> <C> <C>
Interest on fixed-maturity investments............$ 6,663 $ 6,680 $ 5,945
Interest on cash equivalents...................... 536 573 522
-------- -------- --------
Interest income, net........................... 7,199 7,253 6,467
-------- -------- --------
Realized gains - fixed-maturity investments, net.. 140 508 1,163
Realized gains - equities, net.................... - 256 -
-------- -------- --------
Realized investment gains, net................. 140 764 1,163
-------- -------- --------
$ 7,339 $ 8,017 $ 7,630
======== ======== ========
</TABLE>
The amortized cost and fair values of investments are as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR CARRYING
DECEMBER 31, 1997 COST GAINS LOSSES VALUE VALUE
- ----------------------------------------------------------------- ---------- ---------- ---------- ---------- ----------
(In thousands)
<S> <C> <C> <C> <C> <C>
FIXED MATURITIES AVAILABLE FOR SALE:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies........................ $ 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
========== ========== ========== ========== ==========
DECEMBER 31, 1998
- -----------------------------------------------------------------
FIXED MATURITIES AVAILABLE FOR SALE:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies........................ $ 55,018 $ 273 $ (67) $ 55,224 $ 55,224
Debt securities issued by foreign governments.................... 1,510 9 - 1,519 1,519
Obligations of states and political subdivisions................. 12,178 318 - 12,496 12,496
Corporate obligations............................................ 31,333 348 (58) 31,623 31,623
Public utilities................................................. 7,321 141 (18) 7,444 7,444
Mortgage-backed securities....................................... 725 24 - 749 749
---------- ---------- ---------- ---------- ----------
$ 108,085 $ 1,113 $ (143) $ 109,055 $ 109,055
========== ========== ========== ========== ==========
FIXED MATURITIES HELD TO MATURITY:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies........................ $ 1,183 $ 149 $ - $ 1,332 $ 1,183
========== ========== ========== ========== ==========
EQUITY SECURITIES AVAILABLE FOR SALE:
Corporate stock.................................................. $ - $ 191 $ - $ 191 $ 191
========== ========== ========== ========== ==========
</TABLE>
<PAGE>
PAGE F-12
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.
Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without
call or prepayment penalties. The maturities of investments in fixed
maturities at December 31, 1998 are shown below:
<TABLE>
<CAPTION>
AVAILABLE FOR SALE HELD TO MATURITY
----------------------- -----------------------
AMORTIZED AMORTIZED
COST FAIR VALUE COST FAIR VALUE
---------- ---------- ---------- ----------
(In thousands)
<S> <C> <C> <C> <C>
Due in one year or less......$ 22,318 $ 22,370 $ 266 $ 268
Due after one year
through five years...... 46,262 46,547 917 1,064
Due after five years
through ten years....... 36,768 37,304 - -
Due after ten years.......... 2,012 2,085 - -
---------- ---------- ---------- ----------
107,360 108,306 1,183 1,332
Mortgage-backed securities... 725 749 - -
---------- ---------- ---------- ----------
$ 108,085 $ 109,055 $ 1,183 $ 1,332
========== ========== ========== ==========
</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>
1996.........................................$ 178 $ 38
1997......................................... 803 39
1998......................................... 1,224 61
</TABLE>
CIB is required as a foreign reinsurer to secure reserves for unpaid
losses and loss adjustment expenses and unearned premiums for NAICO's benefit.
CIB secures such amounts with a trust arrangement whereby securities are
deposited into a trust account for NAICO's benefit. At December 31, 1997 and
1998, CIB had cash and investments with a carrying value of approximately
$16.7 million and $25.3 million, respectively, deposited in a trust account
for NAICO's benefit.
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, 1997 and 1998, the carrying value of these deposits totaled approximately
$8.2 million.
At December 31, 1998 the total amount of cash and investments restricted
as a result of these arrangements was approximately $33.5 million.
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 expenses, repair expenses, costs of providing legal defense for
policyholders, increased jury awards, and court decisions and legislation that
define and expand insurance coverage subsequent to the time that the insurance
policy was priced and sold. Salvage and subrogation recoverables are accrued
using the "case basis" method for large recoverables and statistical estimates
based on historical experience for smaller recoverables. Recoverable amounts
deducted from the Company's net liability for unpaid losses and loss
adjustment expenses were approximately $3.8 million and $5.3 million at
December 31, 1997 and 1998, respectively. Although such estimates are
management's best estimates of the expected values, the ultimate liability for
unpaid claims may vary from these values. The Company does not discount the
liability for unpaid losses and loss adjustment expenses.
<PAGE>
PAGE F-13
The following table sets forth a reconciliation of the beginning and
ending unpaid losses and loss adjustment expenses which are net of reinsurance
deductions.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1996 1997 1998
---------- ---------- ----------
(In thousands)
<S> <C> <C> <C>
Net balance before provision for
uncollectible reinsurance at
beginning of year.......................$ 81,388 $ 64,430 $ 62,890
---------- ---------- ----------
Net losses and loss adjustment expenses
incurred related to:
Current year............................ 53,314 53,704 42,724
Prior years............................. 77 3,808 5,155
---------- ---------- ----------
Total................................ 53,391 57,512 47,879
---------- ---------- ----------
Net paid losses and loss adjustment
expenses related to:
Current year............................ (23,836) (22,214) (23,152)
Prior years............................. (46,513) (36,838) (36,423)
---------- ---------- ----------
Total................................ (70,349) (59,052) (59,575)
---------- ---------- ----------
Balance before provision for uncollectible
reinsurance at end of year.............. 64,430 62,890 51,194
Adjustments to reinsurance recoverables
on unpaid losses for uncollectible
reinsurance............................. 777 1,163 745
---------- ---------- ----------
Net balance at end of year.................$ 65,207 $ 64,053 $ 51,939
========== ========== ==========
</TABLE>
NAICO does not ordinarily insure against environmental matters as that
term is commonly used. However, in some cases, regulatory filings made by
NAICO on behalf of an insured can make NAICO directly liable to the regulatory
authority for property damage which could include environmental pollution. In
those cases, NAICO ordinarily has recourse against the insured or the surety
bond principal for amounts paid. NAICO has insured certain trucking companies
and pest control operators that are required to provide proof of insurance
which in some cases assures payment for clean-up and remediation of damage
resulting from sudden and accidental release or discharge of contaminants or
other substances which may be classified as pollutants. NAICO also provides
surety bonds for construction contractors that use or have control of such
substances and for contractors that remove and dispose of asbestos as a part
of their contractual obligations. NAICO also insures independent oil and gas
producers that may purchase coverage for the escape of oil, saltwater, or
other substances which may be harmful to persons or property, but may not
generally be classified as pollutants. CIB reinsures a portion of those
risks. NAICO maintains claims records which segregate this type of risk for
the purpose of evaluating environmental risk exposure. Based upon the nature
of such lines of business with insureds of NAICO, and current data regarding
the limited severity and infrequency of such matters, it appears that
potential environmental risks are not a significant portion of claims reserves
and therefore would not likely have a material impact, if any, on the
consolidated financial condition, results of operations or cash flows of the
Company.
NOTE 4. NOTES PAYABLE
During 1996, Chandler USA borrowed $4.5 million from a bank for a three
year term. During the fourth quarter of 1997, the related loan agreement was
amended to provide for additional borrowings up to $8.5 million and to revise
the term to five years with interest payable at a floating rate equal to 1%
over the prime rate published in the Wall Street Journal, which was 7.75% at
December 31, 1998. The revised monthly payment is approximately $179,000
including principal and interest. The principal balance of the note was
approximately $2,646,000 and $7,397,000 at December 31, 1997 and 1998,
respectively. The principal balance at December 31, 1998 is net of an
unamortized loan origination fee of $65,000. Among other things, the loan
agreement precludes Chandler USA from paying shareholder dividends, issuing
stock and limits its ability to incur indebtedness. The bank has informed
Chandler USA that it will consent to the debenture offering described in Note
5, and will waive any restrictions set forth in the loan agreement which might
otherwise prohibit Chandler USA from consummating the offering. Moreover, the
loan agreement requires that certain restrictive covenants relating to a
minimum capital requirement and debt coverage ratio be met. At December 31,
1998, Chandler USA was in compliance with all financial covenants. Proceeds
from the note were used to repay amounts due to CIB. The funds received by
CIB may be used 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
Administrators, Inc., an inactive subsidiary of Chandler USA, with a balance
of $150,000 and $75,000 at December 31, 1997 and 1998, respectively. The note
has an interest rate of 7% per annum and has a final installment of $75,000
plus interest due on October 11, 1999.
In February 1998, Chandler USA entered into a five year loan agreement
with a bank having a principal amount of $2.3 million and an interest rate
of 7.75% per annum. Effective September 28, 1998, the interest rate was
reduced to 7.5% per annum. Monthly payments are approximately $46,000
including principal and interest. The outstanding balance of the note
was approximately $1,938,000 at December 31, 1998. The loan is
collateralized by certain equipment which was purchased with the proceeds
of the loan. The equipment had previously been leased by Chandler USA.
<PAGE>
PAGE F-14
The annual maturities of the notes payable based upon the amounts
outstanding as of December 31, 1998, are as follows:
<TABLE>
<CAPTION>
(In thousands)
<S> <C>
1999..............................$ 2,049
2000.............................. 2,148
2001.............................. 2,343
2002.............................. 2,908
2003.............................. 27
Thereafter........................ -
-------
$ 9,475
=======
</TABLE>
NOTE 5. SUBSEQUENT EVENT
Chandler USA is offering debentures in the aggregate principal amount of
$24,000,000 (the "Debentures"). The terms of the Debentures including the
interest rate and redemption date have not been determined. Chandler USA
plans to use the proceeds of the offering to repay amounts due to CIB; to
retire the debt described in Note 4 above; and for general corporate purposes.
The Debentures are subject to certain transfer restrictions. The Company and
its subsidiaries and affiliates, other than Chandler USA, are not obligated by
the Debentures. Accordingly, the Debentures are effectively subordinated to
all existing and future liabilities and obligations of Chandler USA's
existing and future subsidiaries.
NOTE 6. 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, 1998.
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 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 $947,475 which is reflected as a
separate component of shareholders' equity in the consolidated balance sheets
as of December 31, 1997 and 1998.
See Note 11 regarding stock held by a subsidiary of the Company and stock
rescinded through litigation.
See Note 8 regarding possible taxation of certain income of the Company
to U.S. shareholders with certain ownership percentages.
STATUTORY FINANCIAL INFORMATION AND MINIMUM CAPITAL REQUIREMENTS
Chandler, CIB, NAICO Indemnity and NAICO are required to file financial
statements with insurance regulatory authorities. Chandler and NAICO
Indemnity file financial statements with the Cayman Islands Monetary Authority
and CIB files financial statements with the Supervisor of Insurance in
Barbados. NAICO is required to file financial statements with state
regulatory authorities prepared on a statutory basis which differs from U.S.
GAAP. Statutory net income and statutory surplus of NAICO are as follows:
<TABLE>
<CAPTION>
1996 1997 1998
---------- ---------- ----------
(In thousands)
<S> <C> <C> <C>
Statutory net income.......................$ 998 $ 6,737 $ 6,877
Statutory surplus..........................$ 42,373 $ 45,283 $ 45,327
</TABLE>
<PAGE>
PAGE F-15
Chandler, NAICO Indemnity and CIB 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. CIB 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 and casualty
insurance companies. The RBC standards are designed to assist insurance
regulators in analytically determining a level of capital and surplus that
would be sufficient to withstand reasonably foreseeable adverse events
associated with underwriting risk, investment risk, credit risk and loss
reserve risk. NAICO is subject to the RBC standards. Based on available
information, management believes NAICO complied with the RBC standards at
December 31, 1997 and 1998.
At periodic intervals, various insurance regulatory authorities routinely
examine the required statutory financial statements of NAICO as part of their
legally prescribed oversight of the insurance industry. Based on these
examinations, the regulators can direct such financial statements to be
adjusted in accordance with their findings.
DIVIDEND RESTRICTIONS
As a holding company, the Company may receive cash through equity sales,
borrowings and dividends from its subsidiaries. CIB and NAICO are subject to
regulations which restrict their ability to pay shareholder dividends. The
payment of cash shareholder dividends by CIB to the Company is limited to its
earned surplus (approximately $37.9 million at December 31, 1998) 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 1999
without the approval of the Nebraska Department of Insurance is approximately
$7.3 million. Prior to 1998, NAICO (during the ownership by the Company) had
not paid any cash shareholder dividends. During 1998, NAICO paid a cash
shareholder dividend of $6.0 million to Chandler USA.
See Note 4 regarding a bank loan which precludes Chandler USA from paying
shareholder dividends. The future payment of shareholder dividends also
depends upon the earnings, financial position and cash requirements of the
Company, as well as regulatory limitations and such other factors as the
Board of Directors may deem relevant. CIB has not paid any cash shareholder
dividends.
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, 1998). NAICO paid approximately $526,000, $423,000 and
$561,000 in policyholder dividends during 1996, 1997 and 1998, respectively.
NOTE 7. STOCK OPTIONS AND WARRANTS
The Company has a non-qualified stock option plan (the "Officers' 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 Officers' 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 Officers' Plan
which terminate or are canceled may again be subject to reissuance under the
Officers' Plan. Officers of the Company and its subsidiaries are eligible to
receive options under the Officers' Plan. The Officers' Plan is administered
by a committee of the Company's outside directors appointed by the board of
directors of the Company. No stock options were outstanding under the
Officers' Plan from January 1, 1996 through December 31, 1998.
During the second quarter of 1998 the Company's directors approved the
Directors' Stock Option and Stock Grant Plan (the "Directors' Plan"). The
Directors' Plan provides that the non-employee directors of the Company, other
than Norman Harned, Ronald Lech and M.J. Moroun, are eligible for grants of
stock options and stock grants in accordance with the terms of the Directors'
Plan. Options and stock grants may not be granted under the Directors' Plan
for more than 260,000 shares of common stock of the Company, but this number
may be adjusted to reflect, if deemed appropriate by the board of directors,
any stock dividend, stock split, share combination, recapitalization or the
like, of or by the Company. The exercise price of the stock options shall
generally be equal to the average closing price of common stock of the Company
for the 30 calendar days preceding the date the options are granted. The
option period begins on the effective date of the option grant and terminates
on the tenth anniversary of that date.
<PAGE>
PAGE F-16
The aggregate number of shares of stock awarded to an eligible director
as a stock grant shall total 20,000 shares of common stock of the Company.
The award shall be divided into two equal installments. The first installment
of 10,000 shares shall automatically be awarded as of the first regular board
meeting after an eligible director completes ten continuous years of service
on the board. The second installment of 10,000 shares shall automatically be
awarded as of the first anniversary of the initial stock grant, regardless of
whether the director is still a member of the board. During the second
quarter of 1998, a total of 40,000 shares valued at $250,000, based upon a
weighted average grant-date fair value of $6.25 per share, were awarded to
two directors, and this amount is included in general and administrative
expenses in the Company's consolidated statements of operations. During the
third quarter of 1998, the Company issued 20,000 of the 40,000 shares to the
two directors as required under the Directors' Plan from the Company's stock
held by subsidiary. The difference between the average cost of the shares
issued and the share price at the date of the stock grant was credited to
paid-in surplus.
Each eligible director shall automatically be granted options to purchase
1,500 shares of common stock of the Company as of the first regular board
meeting in each year the director serves on the board. Each eligible
director shall also automatically be granted options to purchase 30,000
shares of common stock of the Company effective as of the first regular board
meeting after the director completes ten continuous years of service on the
board. The options require shareholder approval prior to being exercised.
During the second quarter of 1998, options for 66,000 shares were granted
with an exercise price of $5.92 per share, which resulted in approximately
$22,000 of compensation expense which is included in general and
administrative expenses in the Company's consolidated statements of
operations. As of December 31, 1998, options for 66,000 shares were
outstanding, none of which were exercisable.
The Company applies Accounting Principles Board Opinion 25, ACCOUNTING
FOR STOCK ISSUED TO EMPLOYEES, and related interpretations in accounting for
its stock option plans, as permitted by SFAS No. 123, ACCOUNTING FOR
STOCK-BASED COMPENSATION. SFAS No. 123 requires disclosure of pro forma net
income and basic and diluted earnings per share as if the Company had adopted
the fair value provisions of SFAS No. 123. Had compensation cost been
determined based on the fair value at the grant date of the stock options
in accordance with SFAS No. 123, the Company's pro forma net income for 1998
would have been approximately $3,278,000, and pro forma basic and diluted
earnings per share for 1998 would have been $0.51.
The fair value of each option is estimated on the date of grant using the
Black-Scholes option-pricing model. The weighted average assumptions for the
options granted during 1998 under the Directors' Plan included a risk-free
interest rate of 5.62%; expected volatility of 39.0%; expected life of 5.0
years and no dividend yield. The weighted average grant-date fair value per
option granted during 1998 under the Directors' Plan was $2.81.
NOTE 8. INCOME TAXES
Chandler, CIB and NAICO Indemnity have received tax concessions from the
respective 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 taxes. 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 taxes and may not be
allowed any deductions or credits in determining its tax liability.
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
CIB's stock entitled to vote or 25% or more of the total value of CIB's stock,
then each such person is required to include in his gross income a portion of
any insurance income of CIB 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 CIB ("related person insurance income"
or "RPII"). Under these rules, all U.S. persons who own stock in the Company
would generally be required, subject to the exception discussed hereinafter,
to include in their gross incomes a portion of the RPII received by CIB from
NAICO. However, related person insurance income of CIB 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 CIB's taxable
year, less than 20% of the total combined voting power of all classes of stock
of CIB and less than 20% of the total value of CIB is owned (directly or
indirectly) by persons who are (directly or indirectly) insured under any
policy of insurance or reinsurance issued by CIB, or who are related persons
to any such person.
During 1994, the IRS contended that CIB 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 CIB,
and the Company is a related party to NAICO, which purchases reinsurance from
CIB. 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 CIB 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 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. During 1998, the IRS conducted an
examination of the 1995 U.S. Federal income tax return of CIB. The IRS
completed the examination in the third quarter of 1998, and there were no
proposed adjustments to tax liabilities.
<PAGE>
PAGE F-17
Chandler USA and its wholly owned subsidiaries file a consolidated U.S.
Federal income tax return. The income taxes reflected in the accompanying
consolidated statements of operations differ from those expected using U.S.
Federal enacted income tax rates for the following reasons:
<TABLE>
<CAPTION>
1996 1997 1998
---------- ---------- ----------
(In thousands)
<S> <C> <C> <C>
Computed income tax provision at 34%.......$ 223 $ 413 $ 1,290
Increase (decrease) in income
taxes resulting from:
Expense (benefit) from income (loss) not
subject to U.S. Federal income tax..... (943) 1,384 (1,023)
Amortization of licenses and
other intangibles...................... 380 380 362
Nontaxable income from legal settlement.. (110) - -
Interest income on tax exempt
securities............................. - (32) (298)
Other, net............................... 133 136 22
---------- ---------- ----------
Federal income tax provision (benefit).....$ (317) $ 2,281 $ 353
========== ========== ==========
</TABLE>
U.S. Federal income tax provision (benefit) consists of:
<TABLE>
<CAPTION>
CURRENT DEFERRED TOTAL
---------- ---------- ----------
(In thousands)
<S> <C> <C> <C>
1996.......................................$ (592) $ 275 $ (317)
1997....................................... 2,389 (108) 2,281
1998....................................... 52 301 353
</TABLE>
Deferred income tax provision (benefit) relating to temporary differences
includes the following components:
<TABLE>
<CAPTION>
1996 1997 1998
---------- ---------- ----------
(In thousands)
<S> <C> <C> <C>
Loss reserve discounts.....................$ 450 $ (97) $ 921
Unearned premiums.......................... (292) (58) 395
Deferred policy acquisition costs.......... 158 1 (1,209)
Reserve for uncollectible premiums
receivable and reinsurance recoverables.. 45 188 (9)
Depreciation and lease expense............. (134) (164) (60)
Other...................................... 48 22 263
---------- ---------- ----------
$ 275 $ (108) $ 301
========== ========== ==========
</TABLE>
The tax effect of temporary differences between the consolidated financial
statement carrying amounts and tax bases of assets and liabilities that give
rise to significant portions of the net deferred tax assets, which are included
in other assets, at December 31, relate to the following:
<TABLE>
<CAPTION>
1997 1998
---------- ----------
(In thousands)
<S> <C> <C>
Deferred tax assets:
Loss reserve discounts...............................$ 3,694 $ 2,832
Unearned premiums.................................... 1,825 1,430
Reserve for uncollectible premiums receivable and
reinsurance recoverables........................... 39 180
Net operating loss carryforwards - State............. 1,559 1,670
Other................................................ 288 253
Valuation allowance.................................. (1,559) (1,670)
---------- ----------
Total deferred tax assets............................... 5,846 4,695
---------- ----------
Deferred tax liabilities:
Deferred policy acquisition costs.................... 1,181 (27)
Depreciation and lease expense....................... 743 693
Unrealized gain on investments available for sale.... 166 368
Other................................................ 182 590
---------- ----------
Total deferred tax liabilities.......................... 2,272 1,624
---------- ----------
Net deferred tax assets.................................$ 3,574 $ 3,071
========== ==========
</TABLE>
<PAGE>
PAGE F-18
At December 31, 1998, Chandler USA had net operating loss carryforwards
available for Oklahoma state tax purposes totaling approximately $27.8
million which expire in the years 2005 through 2014. A valuation allowance
has been provided for the tax effect of the state net operating loss
carryforwards since realization of such amounts is not considered more likely
than not.
NOTE 9. EMPLOYEE BENEFITS
Chandler USA and its subsidiaries participate in a defined contribution
retirement plan established under Section 401(k) of the Code. All full time
employees who have completed one year of service and attained age 21 may elect
to participate in the 401(k) plan. Participants may contribute up to 15% of
compensation, not to exceed the statutory limitations which for 1998 was
$10,000. Chandler USA matches 50% of the first $2,000, 40% of the next
$3,000, 30% of the next $3,000 and 25% of the remaining employee contributions
up to a maximum employer contribution of $3,600 per employee per year. In
addition, Chandler USA may make additional annual contributions to the 401(k)
plan at its discretion. Chandler USA's expense for 401(k) plan contributions
was $249,000, $254,000 and $259,000 for 1996, 1997 and 1998, respectively.
NOTE 10. FAIR VALUE DISCLOSURES OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial
instruments is made in accordance with the requirements of SFAS 107,
DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS. The estimated
fair value amounts have been determined by 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. Based on the
short term nature or other relevant characteristics, the Company has concluded
that the carrying value of other assets and liabilities considered financial
instruments, such as cash equivalents, premiums receivable, policyholder
deposits, accrued taxes and other payables, notes payable and premiums
payable, approximates their fair value as of December 31, 1997 and 1998.
The estimated fair values of the Company's fixed-maturity and equity security
investments are disclosed at Note 2.
NOTE 11. LITIGATION
CENTRA LITIGATION -- GENERAL BACKGROUND
CenTra, Inc. ("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 CIB. 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 to purchase 1,117,679 common shares. These common shares were
either owned by Chandler USA (567,350 common shares) or pledged to L&W and
NAICO 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 NAICO 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 NAICO, 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
<PAGE>
PAGE F-19
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 Company's common
stock owned by 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 common
shares was transferred to L&W as payment for one of the agent's debts. In
December 1997, 114,146 common shares were transferred to CIM and the balance
of the pledged common 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. 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 that neither the Company
nor its subsidiaries should take 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 Special
Committee's recommendations were implemented, and reimbursement was made.
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
<PAGE>
PAGE F-20
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 CIB, and in
favor of CenTra and its affiliate, Ammex, Inc. ("Ammex"). CenTra and Ammex
were awarded $6,882,500 in connection with a 1988 stock purchase agreement.
Both judgments related to an alleged failure by the Company to adequately
disclose the fact that ownership of the Company's stock may be subject to
regulation by the Nebraska Department of Insurance under certain
circumstances. Judgment was also entered in favor of CenTra and against
certain officers and/or directors of the Company on the securities claims
relating to CenTra's 1990 purchases and the failure to disclose the
application of Nebraska insurance law, but the judgments were $1 against
each individual defendant on those claims. On ten derivative claims brought
by CenTra, the jury found in CenTra's favor on three. Certain officers were
directed to repay to Chandler USA bonuses received for the years 1988 and 1989
totaling $711,629 and a total of $25,000 for personal use of corporate
aircraft. These amounts are included in other assets in the accompanying
consolidated balance sheets. On the remaining claim relating to the
acquisition of certain insurance agencies in 1988, the jury awarded $1 each
against six officers and/or directors.
Judgment was also entered in favor of NAICO and NAICO Indemnity on
counterclaims against CenTra for CenTra's failure to pay insurance premiums.
Judgment was for the amount of $788,625. During 1998, the judgment was paid
by funds held by the Oklahoma Federal Court aggregating, with interest,
$820,185. DuraRock, a CenTra affiliate, claims $725,000 is owed to it by
NAICO and NAICO Indemnity under certain reinsurance treaties. NAICO and NAICO
Indemnity dispute that claim. In November 1998, DuraRock demanded arbitration
and NAICO and NAICO Indemnity responded by appointing an arbitrator. No
arbitration hearings have been held. The Oklahoma Federal Court's judgment
also upheld a resolution adopted by the Company's 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.
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.
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 liability insurer for costs associated with the defense and
litigation of these matters. The Company and certain affiliates are entitled
to a total of $5 million under the applicable insurance policy to the extent
they have advanced reimbursable expenses. Some amounts have been previously
paid without dispute and the Company is negotiating with the insurer for
payment of the policy balance. The Company and its affiliates 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.
<PAGE>
PAGE F-21
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 CIB 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 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. On March 16, 1998 the CenTra Group filed motions for
an award of costs and attorney fees totaling approximately $4.7 million. On
April 21, 1998, the Oklahoma Federal Court denied the CenTra Group's request.
The CenTra Group did not appeal this decision within the time permitted by
applicable law. Accordingly, the Company reduced the previous first quarter
of 1997 net charge for litigation matters by $3.8 million during the second
quarter of 1998. In subsequent papers filed with the appellate court, CenTra
asserts as error the Oklahoma Federal Court's denial of attorney fees.
On March 23, 1998, the CenTra Group filed a formal notice of intent to
appeal certain orders of the Oklahoma Federal Court and filed the initial
appellate brief on September 9, 1998. All briefing was completed on January
4, 1999 and the appeals are being considered by the U.S. Court of Appeals for
the 10th Circuit. The Company cannot predict when a decision on the appeals
will be made. The CenTra Group's appeals are based upon the Oklahoma Federal
Court's failure to award prejudgment interest, the Oklahoma Federal Court's
refusal to permit the CenTra Group to amend certain pleadings to assert new
claims, the Oklahoma Federal Court's modification of the judgment for
$6,882,500 to require CenTra to return shares of the Company's stock upon
payment of the judgment, and the Oklahoma Federal Court's entry of judgment
in favor of NAICO and certain officers and directors on CenTra's claim based
upon cancellation of its insurance policies by NAICO in 1992. The CenTra
Group is also attempting to appeal the Oklahoma Federal Court's denial of
attorney fees but not the denial of costs. The Company believes the appeal
of this issue is untimely and therefore barred by law. The Company has
elected not to appeal any of the judgments. The individual officers and
directors against whom judgments were entered as described above have all
filed appeals.
The judgments on the derivative claims described above were all entered
in favor of Chandler USA. Chandler USA is, therefore, the judgment creditor
in connection with those derivative claim judgments. Chandler USA appointed
three directors to comprise a Special Litigation Committee on April 25, 1997.
That Special Litigation Committee meets on a regular basis and has been
delegated the authority of the Chandler USA Board of Directors regarding all
issues related to the CenTra litigation in the Oklahoma Federal Court,
including the derivative claim judgments.
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. That 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, and participates in telephone briefings
and discussions at least monthly.
Because all shares of the Company's stock owned by the CenTra Group are
held by the U.S. District Court for the District of Nebraska ("Nebraska
Court"), it is unclear when or if the CenTra Group 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 the CenTra Group can deliver the shares to
the Company. See CenTra Litigation -- Nebraska.
The ultimate outcome of the appeals of the various parties as described
above could have a material adverse effect on the Company and could negatively
impact future earnings. The Company's management believes that adequate
financial resources are available to pay the judgments as they currently exist
or as they may be modified on appeal. As a holding company, the Company may
receive cash through equity sales, borrowings and dividends from its
subsidiaries. CIB and NAICO are subject to various regulations which restrict
their ability to pay shareholder dividends. A reduction in the amount of
invested assets, or an increase in borrowings resulting from potential
payments of these judgments would reduce investment earnings or increase
operating expenses in future periods.
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.
<PAGE>
PAGE F-22
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 a lawsuit 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
Department. 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 Department 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
Department to submit proposals to the Nebraska Court by April 21, 1997 for the
"orderly divestiture and disposition of the stock."
CenTra subsequently appealed the March 25, 1997 order of the Nebraska
Court to the United States Court of Appeals for the Eighth Circuit. CenTra's
appeal of this order resulted in a delay of the deadlines for submitting the
proposals. On October 7, 1997 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
that court's divestiture order. CenTra requested a stay of that order. The
stay was denied 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 the order. On
February 9, 1998 CenTra deposited an additional 1,691,750 shares of Chandler
stock with the Nebraska Court. 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.
On July 29, 1998, the U.S. Court of Appeals for the Eighth Circuit
affirmed the Nebraska Court's order that the CenTra Group be divested of
ownership of control of its shares. This ruling allows the Nebraska Court
to consider divestiture plans which may be submitted by NAICO, the Department
and the CenTra Group. All Chandler shares owned or controlled by the CenTra
Group remain in the Nebraska Court's possession pending further orders by
that court. On October 28, 1998, the CenTra Group filed pleadings in the
Nebraska Court requesting the appointment of a special master to supervise
the divestiture and an independent trustee to hold and vote the Company's
shares owned by the CenTra Group in accordance with specific instructions
pending the final implementation of a divestiture plan. NAICO objected to the
CenTra proposal on November 25, 1998 and responded with a divestiture plan of
its own (the "NAICO Plan"). The Nebraska Court rejected the CenTra proposal
and CenTra responded to the NAICO Plan on December 28, 1998. The Nebraska
Court has made no ruling on the NAICO Plan. NAICO's Plan includes a proposal
whereby the Company would acquire and cancel the shares of Chandler stock
owned or acquired by the CenTra Group. The NAICO Plan has been approved by
the Company's executive committee of the board of directors and the boards of
directors of Chandler USA and NAICO. The Department generally supports the
NAICO Plan. The Nebraska Court has given no indication regarding when it will
rule on the NAICO Plan.
<PAGE>
PAGE F-23
On March 27, 1997 the Nebraska Court declined to exercise jurisdiction
over 550,329 common 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 common shares
was transferred to L&W as payment for one of the agent's debts. In December
1997, L&W transferred 114,146 common shares to CIM and transferred the balance
of the pledged shares 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"). On February 28, 1998, the Michigan Federal Court
ordered the lawsuits transferred to the Oklahoma Federal Court. They have now
been consolidated and have been assigned to the same judge who presided over
the action concluded in April 1997 (see CenTra Litigation -- Oklahoma).
Dispositive motions filed by NAICO, NAICO Indemnity and the other defendants
are currently under consideration by the Oklahoma Federal Court.
During the first quarter of 1997, CIB concluded an arbitration proceeding
involving DuraRock, and CIB recorded approximately $315,000 in litigation and
settlement expenses related to this matter. The Company 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 $147,000 in the fourth quarter of 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 $2.2 million as of
December 31, 1998. 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 liability insurer. As a result of various events in 1995, the
Company recorded an $818,000 estimated recovery of costs from its directors
and officers liability 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 liability
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 liability insurer, no provision has been made in the
accompanying consolidated financial statements related to the advancement of
litigation expenses to certain defendants. The Special Litigation Committees
of the Company and Chandler USA were delegated the authority of the boards of
directors 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.
<PAGE>
PAGE F-24
NOTE 12. 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 construction
surety bonds, property, workers compensation, casualty (including automobile
liability and physical damage, general liability, umbrella liability, and
related professional liability) and group accident and health. CIB reinsures
NAICO for a portion of the risk on the construction surety bonds, workers
compensation and casualty reinsurance programs.
During the first quarter of 1998, NAICO purchased additional reinsurance
under its workers compensation and casualty reinsurance programs that
substantially reduced the combined net retentions in these lines of business.
During the second quarter of 1998, NAICO purchased additional reinsurance
under its construction surety bond reinsurance program. In July 1997, NAICO
purchased additional reinsurance for the California portion of the
nonstandard private-passenger automobile program. The purchase of the
additional reinsurance coverages in 1997 and 1998 substantially reduced the
per occurrence retention for NAICO's workers compensation, casualty, surety
bond and private-passenger automobile lines of business, but results in
significantly lower net premiums earned, losses and loss adjustment expenses
and policy acquisition costs.
In addition, NAICO purchases catastrophe protection to limit its
retention for single loss occurrences involving multiple policies and/or
policyholders, such as floods, winds and severe storms. NAICO also
purchases facultative reinsurance when it writes a risk with limits of
liability exceeding the maximum limits of its treaties or when it otherwise
considers such action appropriate.
Treaty reinsurance may be ceded under treaties on both a pro rata or
proportional basis (where the reinsurer shares proportionately in premiums
and losses) and an excess of loss basis (where only losses above a specific
amount are reinsured). The availability, costs and limits of reinsurance
purchased can vary from year to year based upon prevailing market conditions,
reinsurers underwriting results and NAICO's desired retention levels. A
majority of NAICO's reinsurance programs renew on January 1, April 1 or July 1
of each year. NAICO renewed all January 1, 1999 reinsurance programs. At the
present time, NAICO expects to renew the reinsurance programs that renew on
April 1 and July 1, 1999.
In formulating its reinsurance programs, NAICO considers numerous
factors, the most important of which are the financial stability of the
reinsurer, including its ability to provide sufficient collateral if
required, reinsurance coverage offered and price.
NAICO periodically reviews certain prospective single year reinsurance
treaties, subject to commutation provisions therein, to determine if it is
advantageous to assume the estimated loss exposure on expired insurance
policies covered by such treaties in exchange for return premiums.
Commutation of such reinsurance treaties will be determined in future periods
based on timely review of all available data. 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 probable, which resulted in an increase
in net premiums earned of $730,000, $918,000 and $931,000 in 1996, 1997 and
1998, 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 $2,078,000, $527,000 and $50,000
to policy acquisition costs during 1996, 1997 and 1998, respectively, for
estimated uncollectible reinsurance recoverables from certain unaffiliated
reinsurers.
<PAGE>
PAGE F-25
The effect of reinsurance on premiums written and earned was as follows:
<TABLE>
<CAPTION>
1996 1997 1998
-------------------- -------------------- --------------------
WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED
--------- --------- --------- --------- --------- ---------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Direct.........$103,801 $ 98,550 $123,014 $116,101 $134,436 $126,017
Assumed........ 4,142 4,664 74 608 (107) 54
Ceded.......... (14,228) (13,928) (26,222) (22,030) (68,793) (56,007)
--------- --------- --------- --------- --------- ---------
Net premiums...$ 93,715 $ 89,286 $ 96,866 $ 94,679 $ 65,536 $ 70,064
========= ========= ========= ========= ========= =========
</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 $4.2 million,
$10.6 million and $42.6 million for 1996, 1997 and 1998, respectively.
SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK
NAICO conducts its business through individual independent insurance
agencies and underwriting managers. Certain of these underwriting managers
have provided collateral to NAICO to secure a portion of the premiums
receivable. Substantially all of the principal shareholders of the
independent agencies and underwriting managers have provided personal
guarantees for payment of premiums to NAICO. NAICO also requires certain
policyholders to pay a deposit at the time of inception of coverage to secure
payment of future premiums or other policy related obligations. Receivables
under installment plans do not exceed the corresponding liability for
unearned premiums. Total consolidated premiums receivable at December 31,
1997 and 1998 were $28.1 million and $28.5 million, respectively. Receivables
for deductibles, in most cases, are secured by cash deposits and letters of
credit. At December 31, 1998, the Company maintained custody of such letters
of credit securing these and other transactions totaling approximately $10.5
million, which is a reasonable estimate of their fair value. These letters of
credit are not reflected in the accompanying consolidated financial
statements. There were no unaffiliated independent insurance agents that
produced 10% or more of NAICO's direct written and assumed premiums during
1996, 1997 or 1998.
NAICO's largest underwriting manager was responsible for underwriting
$11.9 million, $12.3 million and $4.0 million of NAICO's direct written and
assumed premiums for the California and Arizona portions of the nonstandard
private-passenger automobile program in 1996, 1997 and 1998, respectively.
The program underwritten by this underwriting manager was discontinued in
1998. NAICO's bail bond underwriting manager was responsible for gross
written premiums of $2.7 million, $2.6 million and $2.8 million during 1996,
1997 and 1998, respectively.
Approximately $9.5 million, or 17% of the Company's reinsurance
recoverables at December 31, 1998 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's
five largest reinsurers (excluding CIB) determined on the basis of net
reinsurance recoverables as of December 31, 1998.
<TABLE>
<CAPTION>
NET CEDED A.M.
REINSURANCE REINSURANCE BEST CO.
NAME OF REINSURER RECOVERABLE (1) PREMIUMS RATING
- ------------------------------- --------------- ----------- --------
(in thousands)
<S> <C> <C> <C>
First Excess and Reinsurance
Corporation................ $ 15,613 $ 21,420 A
Reliance Insurance Company..... 13,948 19,111 A-
SCOR Reinsurance Company....... 5,196 8,061 A+
Jefferson Insurance Company of
New York................... 2,345 3,638 A
Swiss Reinsurance America
Corporation................ 1,900 2,889 A+
--------------- -----------
Top five reinsurers........ $ 39,002 $ 55,119
=============== ===========
All reinsurers............. $ 54,178 $ 68,793
=============== ===========
Percentage of total represented
by top five reinsurers..... 72.0% 80.1%
- -------------------------------
<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, 1998.
</TABLE>
<PAGE> PAGE F-26
In the fourth quarter of 1998, a group of NAICO's agents in Oklahoma and
Texas formed a Cayman Islands based reinsurance company. The primary purpose
of that company is to reinsure a portion of NAICO's net retained liability on
workers compensation, casualty and physical damage business which is placed
with NAICO by these agents. That company's reinsurance obligations to NAICO
are secured by funds held by NAICO and by funds deposited into a trust account
for NAICO's benefit. NAICO loaned funds to certain of the agents which are
secured by the agent's stock in the reinsurance company. The outstanding loan
balances at December 31, 1998 consist of 24 individual loans totaling
approximately $977,000 and are included in other assets in the accompanying
consolidated balance sheet.
OTHER
See Note 11 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 $982,000. 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 former executive officers, Benjamin
T. Walkingstick, resigned as an executive officer and ceased to be employed
by Chandler USA, 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 totaled $10,832
and $10,603 during 1997 and 1998, respectively. Effective January 1, 1999,
Brenda B. Watson, an executive officer and director of the Company and an
executive officer of NAICO and L&W, agreed to modify her employment agreement
so that it terminates on January 1, 2004.
In addition, certain executives are eligible to participate in bonus
plans based upon premium production and/or profitability.
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, $865,000 and $851,000 at December 31, 1996, 1997
and 1998, 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, $64,000 and $54,000 at December 31,
1996, 1997 and 1998, respectively.
At December 31, 1998, the Company's subsidiaries were committed under
noncancellable operating leases for certain equipment and office space.
Rental payments under these leases were $1.1 million in both 1996 and 1997
and were $535,000 in 1998. Future minimum lease payments are as follows:
<TABLE>
<CAPTION>
(In thousands)
<S> <C>
1999..............................$ 400
2000.............................. 290
2001.............................. 235
2002.............................. 135
2003.............................. 91
-------
$ 1,151
=======
</TABLE>
NOTE 13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
NAICO and NAICO Indemnity provided insurance coverage and risk management
services for CenTra and certain of its affiliates (see Note 11). 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. During 1998, the
judgment was paid by funds held by the Oklahoma Federal Court aggregating,
with interest, $820,185. DuraRock, a CenTra affiliate, claims $725,000 is
owed to it by NAICO and NAICO Indemnity under certain reinsurance treaties.
NAICO and NAICO Indemnity dispute that claim. 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.
<PAGE>
PAGE F-27
During 1998, the Company's subsidiaries paid a total of $505,000 to
Liberty Bell and DuraRock which resulted in settlement of certain litigation
and arbitration proceedings. This amount was included in accrued taxes and
other payables in the Company's consolidated balance sheet at December 31,
1997.
DuraRock reinsured NAICO and NAICO Indemnity for substantially all CenTra
risks underwritten by them. As a part of a settlement of certain related
litigation, National Union Fire Insurance Company of Pittsburgh ("National
Union") agreed to assume the reinsurance obligations of DuraRock effective
March 31, 1993. Reinsurance recoverables from National Union totaled
approximately $7.4 million, $3.9 million and $1.5 million as of December 31,
1996, 1997 and 1998, 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 11 and 12).
OTHER
See Note 11 regarding advancement of litigation expenses to certain
officers and directors of the Company in the CenTra litigation.
See Note 12 regarding an insurance commission agreement in 1997.
Chandler USA leases and has made certain improvements to a rural property
in which certain directors and/or officers of the Company own interests.
Under the lease, no cash rental is paid, but Chandler USA drilled a water well
on the property and maintains certain structures it regularly uses. This
property provides recreational activities for the entertainment of customers
and business associates of the Company's U.S. subsidiaries. Chandler USA
incurred approximately $184,000, $159,000 and $217,000 in expenses associated
with this property during 1996, 1997 and 1998, 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 14. SEGMENT INFORMATION
The Company has two reportable operating segments: property and casualty
insurance and agency. The segments are managed separately due to the
differences in the nature of the insurance products and services sold.
The property and casualty segment accounted for 91.5%, 91.6% and 89.6%
of 1996, 1997 and 1998 consolidated revenues before intersegment eliminations,
respectively. The insurance products are underwritten by NAICO and are
marketed through independent insurance agencies, including L&W. NAICO
underwrites various lines of property and casualty insurance, including surety
bonds and workers compensation insurance. NAICO's main areas of concentration
include the construction, manufacturing, oil and gas, wholesale, service and
retail industries along with political subdivisions. The property and
casualty segment operates primarily in Oklahoma and Texas, and other
surrounding states. Oklahoma accounted for approximately 59%, 55% and 55% of
gross written premiums in 1996, 1997 and 1998, respectively, while Texas
accounted for approximately 7%, 18% and 28% of gross written premiums during
the same years. Management evaluates the property and casualty segment's
performance on the basis of growth in gross written premiums and income
before income taxes.
The agency segment accounted for 8.2%, 8.1% and 10.0% of 1996, 1997 and
1998 consolidated revenues before intersegment eliminations, respectively.
L&W is appointed by insurers to solicit applications for policies of
insurance, primarily in Oklahoma. L&W represents personal and commercial
lines insurance companies, and markets property and casualty, individual and
group life, medical and disability income coverages. Major target classes of
business are political subdivisions, healthcare facilities, transportation
companies, manufacturers, contractors, oil & gas, retailers, wholesalers and
service organizations. A large portion of certain classes of business
produced by L&W is placed with NAICO. L&W also acts as a surplus lines
broker specializing in risk management and brokering insurance for commercial
enterprises. L&W acts as the underwriter for a significant portion of
NAICO's construction surety bond program. L&W places direct agency business
as well as business from other agents with specialty insurance companies.
Management evaluates the agency segment's performance on the basis of
commission income generated and income before income taxes.
The Company accounts for intercompany sales and transactions as if they
were to third parties and attempts to set fees consistent with those that
would apply in arm's length transactions with a nonaffiliate. There can be
no assurance the rates charged reflect those that would have been agreed upon
following an arm's length negotiation.
<PAGE>
PAGE F-28
The following table presents a summary of the Company's operating
segments for the years ended December 31:
<TABLE>
<CAPTION>
INTER-
PROPERTY SEGMENT
AND ALL ELIMINA- REPORTED
AGENCY CASUALTY OTHER TIONS BALANCES
--------- --------- --------- --------- ----------
(In thousands)
<S> <C> <C> <C> <C> <C>
1996
Revenues from external
customers............. $ 1,893 $ 90,793 $ 220 $ - $ 92,906
Intersegment revenues.... 6,798 248 138 (7,184) -
Interest income, net..... 70 7,120 9 - 7,199
Interest expense......... - 146 - - 146
Depreciation and
amortization.......... 121 1,110 1,061 - 2,292
Segment profit (loss)
before income
taxes (1)............. 99 1,446 (890) - 655
Segment assets........... 7,930 210,668 314 (12,085) 206,827
1997
Revenues from external
customers............. $ 1,763 $ 95,224 $ 220 $ - $ 97,207
Intersegment revenues.... 7,277 201 138 (7,616) -
Interest income, net..... 56 7,186 11 - 7,253
Interest expense......... 1 462 - - 463
Depreciation and
amortization.......... 121 1,031 1,062 - 2,214
Segment profit (loss)
before income
taxes (1)............. 167 6,874 (5,778) (47) 1,216
Segment assets........... 6,177 217,092 2,656 (15,135) 210,790
1998
Revenues from external
customers............. $ 1,561 $ 70,223 $ 232 $ - $ 72,016
Intersegment revenues.... 7,088 197 150 (7,435) -
Interest income, net..... 55 6,412 - - 6,467
Interest expense......... 2 934 - - 936
Depreciation and
amortization.......... 107 1,355 996 - 2,458
Segment profit (loss)
before income
taxes (1)............. 227 2,075 1,510 (17) 3,795
Segment assets........... 5,323 243,180 4,227 (16,705) 236,025
- ------------------------------
<FN>
(1) Includes net realized investment gains.
</TABLE>
Net premiums earned and losses and loss adjustment expenses within the
property and casualty segment can be identified to Company designated
insurance programs. The Company's chief operating decision makers review net
premiums earned and losses and loss adjustment expenses in assessing the
performance of an insurance program. In addition, the Company's chief
operating decision makers consider many other factors such as the lines of
business offered within an insurance program and the states in which the
insurance programs are offered. Certain discrete financial information is
not readily available by insurance program, including assets, interest income,
and investment gains or losses, allocated to each insurance program. The
Company does not consider its insurance programs to be reportable segments,
however, the following supplemental information pertaining to each insurance
program's net premiums earned and losses and loss adjustment expenses is
presented for the property and casualty segment.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
INSURANCE PROGRAM 1996 1997 1998
- ------------------------------------------ ---------- ---------- ----------
(In thousands)
<S> <C> <C> <C>
NET PREMIUMS EARNED
Standard property and casualty............ $ 38,330 $ 55,527 $ 41,662
Political subdivisions.................... 14,017 14,945 13,073
Surety bonds.............................. 10,020 11,117 9,938
Group accident and health................... 316 2,303 4,646
Nonstandard private-passenger automobile.... 16,595 8,841 482
Other....................................... 10,008 1,946 263
---------- ---------- ----------
$ 89,286 $ 94,679 $ 70,064
========== ========== ==========
LOSSES AND LOSS ADJUSTMENT EXPENSES
Standard property and casualty............ $ 22,627 $ 37,253 $ 31,419
Political subdivisions.................... 8,075 8,490 10,502
Surety bonds.............................. (65) 952 1,569
Group accident and health................... 152 998 4,149
Nonstandard private-passenger automobile.... 14,302 6,386 (182)
Other....................................... 8,300 3,433 422
---------- ---------- ----------
$ 53,391 $ 57,512 $ 47,879
========== ========== ==========
</TABLE>
<PAGE>
PAGE F-29
The following table shows the detail of intersegment eliminations for
segment assets shown in the previous table:
<TABLE>
<CAPTION>
1996 1997 1998
---------- ---------- ----------
(In thousands)
<S> <C> <C> <C>
Segment asset eliminations
Investment in subsidiaries...............$ 475 $ 475 $ 475
Other consolidating adjustments.......... 11,610 14,660 16,230
---------- ---------- ----------
$ 12,085 $ 15,135 $ 16,705
========== ========== ==========
</TABLE>
NOTE 15. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The Company's quarterly results of operations (unaudited) for 1997 and
1998 are as follows:
<TABLE>
<CAPTION>
BASIC AND
NET DILUTED EARNINGS
TOTAL INCOME (LOSS) PER
REVENUES (LOSS) COMMON SHARE
---------- ---------- ----------------
(In thousands except per
share amounts)
<S> <C> <C> <C>
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
1998
- ----------------------------------
First quarter..................$ 18,550 $ 974 $ 0.15
Second quarter................. 19,853 1,041 0.16
Third quarter.................. 20,248 605 0.09
Fourth quarter................. 20,995 832 0.13
</TABLE>
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.
Net realized investment 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.
In the second quarter of 1998, the Company reduced the previous 1997 net
charge for litigation matters by $3.8 million due to the Oklahoma Federal
Court's denial of the CenTra Group's request for costs and attorney fees.
* * * * * * *
<PAGE>
PAGE F-30
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,
1998 and 1997, and the related consolidated statements of operations,
comprehensive income, shareholders' equity and cash flows for each of the
three years in the period ended December 31, 1998 (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, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 1998 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 11 to the consolidated financial statements, the Company
is involved in various legal proceedings, the outcome of which is uncertain.
/s/ Deloitte & Touche
DELOITTE & TOUCHE
Grand Cayman, Cayman Islands
March 5, 1999
<PAGE>
PAGE F-31
SCHEDULE I
CHANDLER INSURANCE COMPANY, LTD. AND SUBSIDIARIES
SUMMARY OF INVESTMENTS - OTHER
THAN INVESTMENTS IN RELATED PARTIES
AS OF DECEMBER 31, 1998
(Amounts in thousands)
<TABLE>
<CAPTION>
AMOUNT AT WHICH
SHOWN IN THE
TYPE OF INVESTMENT COST FAIR VALUE BALANCE SHEET
- --------------------------------------- ---------- ---------- ---------------
<S> <C> <C> <C>
FIXED MATURITIES AVAILABLE FOR SALE:
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies........... $ 55,018 $ 55,224 $ 55,224
Debt securities issued by foreign
governments......................... 1,510 1,519 1,519
Obligations of states and political
subdivisions........................ 12,178 12,496 12,496
Corporate obligations.................. 31,333 31,623 31,623
Public utilities....................... 7,321 7,444 7,444
Mortgage-backed securities............. 725 749 749
---------- ---------- ---------------
108,085 109,055 109,055
FIXED MATURITIES HELD TO MATURITY:
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies........... 1,183 1,332 1,183
EQUITY SECURITIES AVAILABLE FOR SALE:
Corporate stock........................ - 191 191
---------- ---------- ---------------
Total investments................... $ 109,268 $ 110,578 $ 110,429
========== ========== ===============
</TABLE>
<PAGE>
PAGE F-32
SCHEDULE II
CHANDLER INSURANCE COMPANY, LTD. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CHANDLER INSURANCE COMPANY, LTD.
(PARENT COMPANY ONLY)
BALANCE SHEETS
(Amounts in thousands except share amounts)
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1997 1998
---------- ----------
<S> <C> <C>
ASSETS
Cash and cash equivalents................................$ 16 $ 15
Premiums receivable...................................... - 10
Investment in subsidiaries, net.......................... 74,937 75,268
---------- ----------
Total assets.............................................$ 74,953 $ 75,293
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Litigation liabilities................................$ 16,618 $ 13,228
---------- ----------
Total liabilities........................................ 16,618 13,228
---------- ----------
Shareholders' equity
Common stock, $1.67 par value, 10,000,000 shares
authorized;
6,941,708 shares issued............................ 11,593 11,593
Paid-in surplus....................................... 34,942 34,983
Common stock to be issued (20,000 shares)............. - 125
Capital redemption reserve............................ 947 947
Retained earnings..................................... 24,886 28,328
Less: Stock held by subsidiary, at cost (494,617 and
544,475 shares in 1997 and 1998, respectively)..... (2,487) (2,905)
Less: Stock rescinded through litigation (1,660,125
shares)............................................ (11,799) (11,799)
Accumulated other comprehensive income:
Unrealized gain on investments available for sale,
net of income tax.................................. 253 793
---------- ----------
Total shareholders' equity............................... 58,335 62,065
---------- ----------
Total liabilities and shareholders' equity...............$ 74,953 $ 75,293
========== ==========
</TABLE>
<PAGE>
PAGE F-33
SCHEDULE II
CHANDLER INSURANCE COMPANY, LTD. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CHANDLER INSURANCE COMPANY, LTD.
(PARENT COMPANY ONLY)
STATEMENTS OF OPERATIONS
(Amounts in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1996 1997 1998
---------- ---------- ----------
<S> <C> <C> <C>
Net premiums earned.........................$ - $ - $ 37
---------- ---------- ----------
Operating costs and expenses
Losses and loss adjustment expenses...... - - 22
Policy acquisition costs................. - - 6
General and administrative expenses...... - - 272
Litigation expenses, net................. - 4,819 (3,390)
---------- ---------- ----------
Total operating costs and expenses.... - 4,819 (3,090)
---------- ---------- ----------
Income (loss) before equity in net income
of subsidiaries.......................... - (4,819) 3,127
Equity in net income of subsidiaries........ 972 3,754 315
---------- ---------- ----------
Net income (loss)...........................$ 972 $ (1,065) $ 3,442
========== ========== ==========
</TABLE>
<PAGE>
PAGE F-34
SCHEDULE II
CHANDLER INSURANCE COMPANY, LTD. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CHANDLER INSURANCE COMPANY, LTD.
(PARENT COMPANY ONLY)
STATEMENTS OF CASH FLOWS
(Amounts in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1996 1997 1998
---------- ---------- ----------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss).......................$ 972 $ (1,065) $ 3,442
Adjustments to reconcile net income
(loss) to cash applied to
operating activities:
Earned compensation: non-employee
director stock option and
stock grant plan.................. - - 272
Net income of subsidiaries not
distributed to parent.............. (972) (3,754) (315)
Net change in non-cash balances relating
to operating activities:
Premiums receivable................... - - (10)
Litigation liabilities................ - 4,819 (3,390)
--------- ---------- ----------
Cash applied to operating activities.. - - (1)
--------- ---------- ----------
Decrease in cash and cash equivalents....... - - (1)
Cash and cash equivalents at beginning
of year.................................. 16 16 16
--------- ---------- ----------
Cash and cash equivalents at end of year....$ 16 $ 16 $ 15
========= ========== ==========
</TABLE>
<PAGE>
PAGE F-35
SCHEDULE III
CHANDLER INSURANCE COMPANY, LTD. AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
(Amounts in thousands)
<TABLE>
<CAPTION>
FUTURE
POLICY OTHER AMORTI-
DEFERRED BENEFITS, POLICY ZATION OF NET
POLICY LOSSES, CLAIMS CLAIMS, DEFERRED PREMIUMS
ACQUISI- CLAIMS AND NET LOSSES AND POLICY OTHER WRITTEN
TION AND LOSS UNEARNED BENEFITS PREMIUM INTEREST SETTLEMENT ACQUISI- OPERATING AND
COSTS EXPENSES PREMIUMS PAYABLE REVENUE INCOME EXPENSES TION COSTS EXPENSES ASSUMED
-------- ---------- --------- ---------- ---------- --------- ----------- ------------ --------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
YEAR ENDED
DECEMBER 31, 1996
Property
and
casualty...$ 4,993 $ 79,639 $ 36,009 $ 4,016 $ 89,286 $ 7,121 $ 53,391 $ 25,517 $ 10,762 $ 93,715
Agency...... - - - - - 70 - 6,606 2,057 -
Other....... - - - - - 8 - - 1,257 -
-------- ---------- --------- ---------- ---------- --------- ----------- ------------ --------- ---------
Total.......$ 4,993 $ 79,639 $ 36,009 $ 4,016 $ 89,286 $ 7,199 $ 53,391 $ 32,123 $ 14,076 $ 93,715
======== ========== ========= ========== ========== ========= =========== ============ ========= =========
YEAR ENDED
DECEMBER 31, 1997
Property
and
casualty...$ 5,312 $ 74,929 $ 42,388 $ 4,830 $ 94,679 $ 7,186 $ 57,512 $ 21,064 $ 10,309 $ 96,866
Agency...... - - - - - 56 - 7,081 1,896 -
Other....... - - - - - 11 - - 6,146 -
-------- ---------- --------- ---------- ---------- --------- ----------- ------------ --------- ---------
Total.......$ 5,312 $ 74,929 $ 42,388 $ 4,830 $ 94,679 $ 7,253 $ 57,512 $ 28,145 $ 18,351 $ 96,866
======== ========== ========= ========== ========== ========= =========== ============ ========= =========
YEAR ENDED
DECEMBER 31, 1998
Property
and
casualty...$ 2,381 $ 80,909 $ 50,647 $ 4,936 $ 70,064 $ 6,411 $ 47,879 $ 10,099 $ 10,510 $ 65,536
Agency...... - - - - - 55 - 6,934 1,540 -
Other....... - - - - - 1 - - (1,111) -
-------- ---------- --------- ---------- ---------- --------- ----------- ------------ --------- ---------
Total.......$ 2,381 $ 80,909 $ 50,647 $ 4,936 $ 70,064 $ 6,467 $ 47,879 $ 17,033 $ 10,939 $ 65,536
======== ========== ========= ========== ========== ========= =========== ============ ========= =========
</TABLE>
<PAGE>
PAGE F-36
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, 1996
Property and casualty..$103,801 $(14,228) $ 4,142 $ 93,715 4.42%
========= ========= ========= ========= ==========
Year ended
December 31, 1997
Property and casualty..$123,014 $(26,222) $ 74 $ 96,866 0.08 %
========= ========= ========= ========= ==========
Year ended
December 31, 1998
Property and casualty..$134,436 $(68,793) $ (107) $ 65,536 (0.16)%
========= ========= ========= ========= ==========
</TABLE>
<PAGE>
PAGE F-37
SCHEDULE V
CHANDLER INSURANCE COMPANY, LTD. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(Amounts 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:
1996.....................$ 177 $ 1,768 $ (1,768) $ 177
========= ============== ========== ==========
1997.....................$ 177 $ 52 $ (114) $ 115
========= ============== ========== ==========
1998.....................$ 115 $ 152 $ (67) $ 200
========= ============== ========== ==========
Allowance for non-collection
of reinsurance recoverables
on paid and unpaid losses:
1996.....................$ 614 $ 2,078 $ (2,201) $ 491
========= ============== ========== ==========
1997.....................$ 491 $ 527 $ (353) $ 665
========= ============== ========== ==========
1998.....................$ 665 $ 50 $ (110) $ 605
========= ============== ========== ==========
</TABLE>
<PAGE>
PAGE F-38
SCHEDULE VI
CHANDLER INSURANCE COMPANY, LTD. AND SUBSIDIARIES
SUPPLEMENTAL INFORMATION
(FOR PROPERTY-CASUALTY INSURANCE UNDERWRITERS)
(Amounts in thousands)
<TABLE>
<CAPTION>
DISCOUNT PAID LOSSES
DEDUCTED AND LOSS
FROM ADJUSTMENT
RESERVES EXPENSES
----------- -----------
<S> <C> <C>
Year ended December 31, 1996
Property-casualty.............................$ - $ 70,349
=========== ===========
Year ended December 31, 1997
Property-casualty.............................$ - $ 59,052
=========== ===========
Year ended December 31, 1998
Property-casualty.............................$ - $ 59,575
=========== ===========
</TABLE>
<PAGE>
PAGE F-39
EXHIBIT 21.1
CHANDLER INSURANCE COMPANY, LTD. AND SUBSIDIARIES
LIST OF ALL SUBSIDIARIES
1. Chandler Insurance (Barbados), Ltd., a Barbados company ("CIB") 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 CIB.
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 CIB.
<PAGE>
PAGE F-40
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 5, 1999 (which expresses
an unqualified opinion and includes an explanatory paragraph relating to
litigation discussed in Note 11) appearing in the Annual Report on Form 10-K
of Chandler Insurance Company, Ltd. for the year ended December 31, 1998.
/s/ Deloitte & Touche
DELOITTE & TOUCHE
Grand Cayman, Cayman Islands
March 26, 1999<PAGE>
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CHANDLER
INSURANCE COMPANY, LTD.'S DECEMBER 31, 1998 FORM 10-K AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<DEBT-HELD-FOR-SALE> 109,055
<DEBT-CARRYING-VALUE> 1,183
<DEBT-MARKET-VALUE> 1,332
<EQUITIES> 191
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 110,429
<CASH> 10,383
<RECOVER-REINSURE> 2,760
<DEFERRED-ACQUISITION> 2,381
<TOTAL-ASSETS> 236,025
<POLICY-LOSSES> 80,909
<UNEARNED-PREMIUMS> 50,647
<POLICY-OTHER> 4,936
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 9,410
0
0
<COMMON> 11,593
<OTHER-SE> 50,472
<TOTAL-LIABILITY-AND-EQUITY> 236,025
70,064
<INVESTMENT-INCOME> 6,467
<INVESTMENT-GAINS> 1,163
<OTHER-INCOME> 1,952
<BENEFITS> 47,879
<UNDERWRITING-AMORTIZATION> 17,033
<UNDERWRITING-OTHER> 10,939
<INCOME-PRETAX> 3,795
<INCOME-TAX> 353
<INCOME-CONTINUING> 3,442
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,442
<EPS-PRIMARY> 0.54
<EPS-DILUTED> 0.53
<RESERVE-OPEN> 64,053
<PROVISION-CURRENT> 42,724
<PROVISION-PRIOR> 5,155
<PAYMENTS-CURRENT> 23,152
<PAYMENTS-PRIOR> 36,423
<RESERVE-CLOSE> 51,939
<CUMULATIVE-DEFICIENCY> 5,155
</TABLE>
