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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, 2001
COMMISSION FILE NUMBER: 1-15135
CHANDLER (U.S.A.), INC.
(Exact name of registrant as specified in its charter)
OKLAHOMA 73-1325906
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1010 MANVEL AVENUE
CHANDLER, OKLAHOMA 74834
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 405-258-0804
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
----------------------------------- -----------------------------------------
$24,000,000 8.75% SENIOR DEBENTURES AMERICAN STOCK EXCHANGE
Securities registered pursuant to Section 12(g) of the Act:
NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
YES X NO
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. X
-----
Aggregate market value of the voting stock held by non-affiliates of the
registrant on February 28, 2002: None.
The number of common shares, $1.00 par value, of the registrant outstanding on
February 28, 2002 was 2,484, which are owned by Chandler Insurance (Barbados),
Ltd., a wholly owned subsidiary of Chandler Insurance Company, Ltd.
DOCUMENTS INCORPORATED BY REFERENCE
Registrant does not incorporate by reference in this report any annual
report, proxy statement, or Rule 424 prospectus.
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PAGE 1
PART I
FORWARD-LOOKING STATEMENTS
Some of the statements made in this Form 10-K report, as well as
statements made by Chandler (U.S.A.), Inc. ("Chandler USA") in periodic press
releases and oral statements made by Chandler USA's officials constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements involve known
and unknown risks, uncertainties and other factors that may cause the actual
results, performance or achievements of Chandler USA to be materially
different from any future results, performance or achievements expressed or
implied by the forward-looking statements. Such factors include, among other
things, (i) general economic and business conditions; (ii) interest rate
changes; (iii) competition and regulatory environment in which Chandler USA
and its subsidiaries operate; (iv) claims frequency; (v) claims severity;
(vi) the number of new and renewal policy applications submitted to National
American Insurance Company ("NAICO") by its agents; (vii) the ability of
NAICO to obtain adequate reinsurance in amounts and at rates that will not
adversely affect its competitive position; (viii) the ability of NAICO to
maintain favorable insurance company ratings; and (ix) other factors
including ongoing litigation matters.
ITEM 1. BUSINESS
GENERAL
Chandler USA is an insurance holding company that provides administrative
services to its wholly owned subsidiaries NAICO and LaGere & Walkingstick
Insurance Agency, Inc. ("L&W"). Through its subsidiaries, Chandler USA
operates in two business segments: property and casualty insurance and
insurance agency operations. Chandler USA is an Oklahoma corporation which
is wholly owned by Chandler Insurance (Barbados), Ltd. ("Chandler Barbados"),
which, in turn, is wholly owned by Chandler Insurance Company, Ltd.
("Chandler Insurance"), a Cayman Islands company. In March 2001, Chandler
Insurance became a privately owned company that is owned by W. Brent LaGere
and Mark T. Paden. Mr. LaGere currently serves as Chairman of the Board and
Chief Executive Officer of Chandler USA and its subsidiaries, and Mr. Paden
serves as President and Chief Operating Officer of Chandler USA and its
subsidiaries. Chandler USA is headquartered in Chandler, Oklahoma, in
facilities also occupied by NAICO and L&W.
NAICO is one of the leading commercial business insurance writers in
Oklahoma, providing property and casualty coverage for businesses in various
industries. NAICO has a network of independent agents, totaling approximately
200 at December 31, 2001, that market NAICO's insurance products. Independent
agents originate substantially all of NAICO's business. NAICO is licensed to
write property and casualty coverage in 45 states and the District of Columbia
and is authorized by the United States Department of the Treasury to write
surety bonds for contractors on federal projects. Effective February 5, 2002,
NAICO's rating from A.M. Best Company was raised from "B+ (Very Good)" to
"B++ (Very Good)." A.M. Best Company is an insurance rating agency. NAICO is
also rated "BBB (Good)" by Standard & Poor's rating agency. These ratings are
independent opinions of a company's financial strength, operating performance
and ability to meet its obligations to policyholders.
L&W is an independent insurance agency that represents various insurance
companies providing a variety of property and casualty, individual and group
life, medical and disability income coverages. L&W also acts as a surplus
lines broker specializing in risk management and brokering insurance primarily
for commercial enterprises.
Chandler Barbados is a Barbados company and a wholly owned subsidiary of
Chandler Insurance that reinsures risks underwritten by NAICO. NAICO retains
a portion of each risk, then transfers the balance to reinsurance companies
including Chandler Barbados. Chandler Insurance reinsures Chandler Barbados
for a portion of the risk that it assumes from NAICO.
GOING PRIVATE TRANSACTION - PARENT COMPANY
A special meeting of shareholders of Chandler USA's indirect parent,
Chandler Insurance, was held on March 5, 2001. Three proposals which
constitute a going private transaction were approved at the meeting, and
Chandler Insurance completed the going private transaction in March 2001. The
Oklahoma Department of Insurance approved the change of control resulting from
the going private transaction. Chandler Insurance has terminated its Exchange
Act registration and no longer files reports with the Securities and Exchange
Commission.
PAGE 2
Chandler Insurance financed the going private transaction through (i) a
$2.4 million sale of Chandler Insurance Class A Common Shares to Messrs.
LaGere and Paden, (ii) a $10.7 million intercompany loan from Chandler
Barbados, and (iii) proceeds of approximately $735,000 from the exercise of
outstanding Chandler Insurance options. Chandler USA loaned approximately
$10.7 million to Chandler Barbados. Chandler USA's intercompany loan to
Chandler Barbados was financed by a $3.8 million sale and leaseback
transaction for certain equipment owned by Chandler USA and a $7.0 million
dividend declared and paid by NAICO.
INSURANCE PROGRAMS
NAICO writes various property and casualty insurance products through
three primary marketing programs. The programs are standard property and
casualty, political subdivisions and surety bonds.
STANDARD PROPERTY AND CASUALTY PROGRAM
NAICO offers workers compensation, automobile liability and physical
damage, general and umbrella liability and property coverages under its
standard property and casualty program. In marketing these products, NAICO
targets companies in the construction, manufacturing, wholesale, service, oil
and gas, and retail industries. NAICO writes this business principally in
Oklahoma and Texas.
POLITICAL SUBDIVISIONS PROGRAM
Under the political subdivisions program, NAICO writes insurance policies
for school districts and municipalities. As of December 31, 2001, NAICO
insured 541 school districts including 526 school districts in Oklahoma. The
coverages offered include workers compensation, automobile liability,
automobile physical damage, general liability, property and school board legal
liability.
NAICO also writes property and casualty insurance for municipalities
primarily in Oklahoma. The coverages offered include workers compensation,
automobile and general liability, automobile physical damage, property and
public officials liability insurance. As of December 31, 2001, NAICO insured
135 municipalities.
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 Texas and Oklahoma. 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.
The following table shows gross premiums earned and net premiums earned
by insurance program for the years 1999, 2000 and 2001. The term "gross
premiums earned" means gross premiums written (before reductions for premiums
ceded to reinsurers) less the increases or plus the decreases in the gross
unearned premium reserve for the unexpired portion of the policy term beyond
the current accounting period. The term "net premiums earned" means gross
premiums earned less reductions for earned premiums ceded to reinsurers. See
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS."
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
----------------------------- -----------------------------
INSURANCE PROGRAMS 1999 2000 2001 1999 2000 2001
- ------------------------------------ --------- --------- --------- --------- --------- ---------
(In thousands)
Standard property and casualty...... $ 99,512 $139,051 $128,554 $ 56,673 $ 62,823 $ 53,130
Political subdivisions ............. 29,994 34,353 34,178 14,320 12,826 12,534
Surety bonds ....................... 13,660 13,691 8,796 7,835 6,467 4,125
Group accident and health (1) ...... 9,098 3,394 342 8,195 3,190 319
Other (2) .......................... 183 278 (271) 75 213 (123)
--------- --------- --------- --------- --------- ---------
TOTAL .............................. $152,447 $190,767 $171,599 $ 87,098 $ 85,519 $ 69,985
========= ========= ========= ========= ========= =========
- -----------------------
(1) The group accident and health program was discontinued during 2000.
(2) This category is comprised primarily of the run-off of other discontinued programs and
NAICO's participation in various mandatory workers compensation pools and assigned risks.
PAGE 3
LINES OF INSURANCE
The lines of insurance written by NAICO through its programs are workers
compensation, automobile liability, surety, accident and health, automobile
physical damage, property, inland marine and other liability lines, which
include general and professional liability lines. The following table shows
net premiums earned as a percentage of total net premiums earned by each line
of insurance written by NAICO during the period indicated.
YEAR ENDED DECEMBER 31,
--------------------------------------------
1997 1998 1999 2000 2001
-------- -------- -------- -------- --------
Other liability ................................... 13% 22% 19% 25% 25%
Workers compensation .............................. 44% 19% 34% 25% 24%
Automobile liability .............................. 17% 22% 17% 20% 19%
Automobile physical damage ........................ 7% 9% 8% 13% 17%
Property .......................................... 2% 4% 3% 4% 7%
Surety ............................................ 13% 14% 9% 8% 6%
Inland marine ..................................... 1% 1% 1% 1% 2%
Accident and health ............................... 3% 9% 9% 4% -%
-------- -------- -------- -------- --------
Total ........................................ 100% 100% 100% 100% 100%
======== ======== ======== ======== ========
AGENCY AND BROKERAGE
L&W is appointed by insurers to solicit applications for insurance
policies, primarily in Oklahoma. L&W represents various personal and
commercial lines insurance companies in marketing property and casualty
insurance. L&W also markets individual and group life, medical and disability
income coverage. Major target classes of business include political
subdivisions, health care facilities, transportation companies, manufacturers,
contractors, energy businesses, retailers, wholesalers and service
organizations. L&W places a large portion of its property and casualty
business with NAICO. It also acts as a surplus lines broker specializing in
risk management and brokering insurance for commercial enterprises. L&W
places direct agency business as well as business from other agents with
specialty insurance companies.
L&W acts as a broker for NAICO, accepting applications for insurance from
independent agents who, in many instances, are not agents appointed directly
by NAICO.
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 1999, 2000 and 2001,
the gross written premiums in this program were $2.8 million, $2.5 million and
$2.3 million, respectively. This underwriting manager operates through a
network of bail bond agents who submit applications to the underwriting
manager. If the application meets the specific guidelines set by the
underwriting manager, a bail bond is issued. This underwriting manager is an
independent contractor and is responsible for collection of all premiums and
payment of all commissions to bail bond agents. Additionally, it is
responsible for all claims and recoveries and is required to maintain
collateral security for each bond.
NAICO's claim department reviews and administers all claims. When a
claim is received, it is reviewed and assigned to an in-house claim adjuster
based on the type and geographic location of the claim, its severity and its
class of business. NAICO's claim department is responsible for reviewing each
claim, obtaining necessary documentation and establishing loss and loss
adjustment expense reserves. NAICO's in-house claims staff handles and
supervises the claims, coordinates with outside legal counsel and independent
claims adjusters if necessary, and processes the claims to conclusion.
PAGE 4
REINSURANCE
In the ordinary course of business, NAICO cedes insurance risks and a
portion of the insurance premiums to its reinsurers under various reinsurance
contracts that cover individual risks (facultative reinsurance) or entire
classes of business (treaty reinsurance). Reinsurance provides greater
diversification of insurance risk associated with business written and also
reduces NAICO's exposure from high policy limits or from catastrophic events
and hazards of an unusual nature. Amounts recoverable from reinsurers are
estimated in a manner consistent with the claim liability associated with the
reinsured policies. In formulating its reinsurance programs, NAICO considers
numerous factors, including the financial stability of the reinsurer, the
reinsurer's ability to provide sufficient collateral (if required),
reinsurance coverage offered and price.
Treaty reinsurance may be ceded under treaties on both a pro rata or
proportional basis (where the reinsurer shares proportionately in premiums and
losses) and an excess of loss basis (where only losses above a specific amount
are reinsured). The availability, costs and limits of reinsurance purchased
varies from year to year based upon prevailing market conditions, reinsurers'
underwriting results and NAICO's desired risk retention levels. A majority
of NAICO's reinsurance programs renew on January 1, April 1 or July 1 of each
year. NAICO renewed all January 1, 2002 reinsurance programs. At the present
time, NAICO expects to renew the reinsurance programs that renew on April 1
or July 1, 2002, as applicable.
NAICO has structured separate reinsurance programs for construction
surety bonds, property (including inland marine), workers compensation,
casualty (including automobile liability, general liability, umbrella
liability and related professional liability), and automobile physical
damage. Chandler Barbados reinsures NAICO for a portion of the risk on
NAICO's construction surety bonds, workers compensation and casualty
reinsurance programs. A portion of the risk that Chandler Barbados assumes
from NAICO is reinsured by Chandler Insurance.
Under the 1999 workers compensation reinsurance program, NAICO's net
retention was 50% of the first $10,000 of loss per occurrence plus 75% of
$490,000 excess of $10,000 of loss per occurrence. Effective January 1, 2000,
NAICO's net retention was reduced to 42.5% of the first $10,000 of loss per
occurrence plus 37.5% of $90,000 excess of $10,000 of loss per occurrence.
Effective October 1, 2000, NAICO purchased quota share reinsurance which
reduced NAICO's net retention to 34% of the first $10,000 of loss per
occurrence plus 30% of $90,000 excess of $10,000 of loss per occurrence.
Effective July 1, 2001, NAICO added 28% of the $100,000 excess of $100,000 of
loss per occurrence layer to its net retention. Effective January 1, 2002,
NAICO's net retention increased to 50% of the first $200,000 of loss per
occurrence.
Under the 1999 casualty reinsurance program, NAICO retained 80% of the
first $250,000 of loss per occurrence. Effective January 1, 2000, NAICO's
retention was reduced to 80% of the first $100,000 of loss per occurrence.
Effective October 1, 2000, NAICO purchased quota share reinsurance which
reduced NAICO's net retention to 64% of the first $100,000 of loss per
occurrence. Effective July 1, 2001, NAICO's net retention increased to 64%
of the first $100,000 of loss per occurrence plus 60% of $150,000 excess of
$100,000 of loss per occurrence plus 40% of $250,000 excess of $250,000 of
loss per occurrence. Effective January 1, 2002, NAICO's net retention
increased to 80% of the first $250,000 of loss per occurrence plus 40% of
$250,000 excess of $250,000 of loss per occurrence.
Under the construction surety bond reinsurance program, NAICO's net
retention was 50% of the first $250,000 per principal (e.g., contractor)
during 1999 and 2000. Effective April 1, 2001, NAICO's net retention
increased to 50% of the first $350,000 per principal.
Under the 1999 and 2000 property reinsurance program, NAICO retained 30%
of the first $500,000 of risk for each loss per risk or location. Effective
January 1, 2001, NAICO retains 33% of the first $1,515,152 of risk for each
loss per risk or location.
NAICO purchases catastrophe protection for its automobile physical damage
and certain property coverages to limit its retention for single loss
occurrences involving multiple policies and/or policyholders resulting from
perils such as floods, winds and severe storms. This catastrophe protection
is purchased primarily from Lloyd's of London. Under its 1999 and 2000
automobile physical damage reinsurance program, NAICO retained the first
$250,000 of loss per occurrence, plus 5% of amounts exceeding $250,000 of loss
per occurrence up to $1 million of loss per occurrence. Effective January 1,
2001, NAICO retains the first $500,000 of loss per occurrence, plus 5% of
amounts exceeding $500,000 of loss per occurrence up to $1 million of loss per
occurrence. NAICO has also purchased reinsurance which limits its net
retained loss for both automobile physical damage and property losses to
$1,000,000 for each loss occurrence. NAICO also purchases facultative
reinsurance when it writes a risk with limits of liability exceeding the
maximum limits of its treaties or when it otherwise considers such action
appropriate.
PAGE 5
The following table sets forth certain information related to NAICO's
five largest reinsurers determined on the basis of net reinsurance
recoverables as of December 31, 2001.
CEDED REINSURANCE
NET PREMIUMS FOR A.M. BEST
REINSURANCE THE YEAR ENDED COMPANY
NAME OF REINSURER RECOVERABLE (1) DECEMBER 31, 2001 RATING
- --------------------------------------------------------- --------------- ------------------ ---------
(Dollars in thousands)
Swiss Reinsurance America Corporation ................... $ 29,979 $ 22,275 A++
GE Reinsurance Corporation .............................. 18,749 13,348 A++
Chandler Barbados ....................................... 17,794 23,455 -(2)
Zurich American Insurance Company ....................... 7,864 - A+
Red River Reinsurance, Ltd. ............................. 5,642 5,933 -(3)
--------------- ------------------
Top five reinsurers ................................ $ 80,028 $ 65,011
=============== ==================
All reinsurers ..................................... $ 98,985 $ 93,541
=============== ==================
Percentage of total represented by top five reinsurers... 81% 70%
- ---------------------------------------------------------
(1) Includes losses and loss adjustment expenses paid and outstanding, unpaid losses and
loss adjustment expenses and prepaid reinsurance premiums recoverable from reinsurers
as of December 31, 2001.
(2) Chandler Barbados owns 100% of the common stock of Chandler USA, which in turn owns
100% of the common stock of NAICO. Although Chandler Barbados is not subject to the
minimum capital, audit, reporting and other requirements imposed by regulation upon
United States reinsurance companies, as a foreign reinsurer, it is required to secure
its reinsurance obligations by depositing acceptable securities in trust for NAICO's
benefit. At December 31, 2001, Chandler Barbados had cash and investments with a fair
value of $19.3 million deposited in a trust account for the benefit of NAICO.
(3) Red River Reinsurance, Ltd. ("Red River") is required to secure its reinsurance obligations
by depositing acceptable securities in trust for NAICO's benefit. At December 31, 2001,
Red River's reinsurance recoverables were collateralized by cash and investments with a
fair value of $5.4 million deposited in a trust account for the benefit of NAICO and by
premiums payable to Red River of approximately $1.1 million.
Transamerica Occidental Life Insurance Company ("Transamerica") reinsured
NAICO for certain workers compensation risks during 1989, 1990 and 1991.
Beginning in 1996, Transamerica refused to pay NAICO for balances that it owed
under the reinsurance treaties. Transamerica owed NAICO approximately $1.5
million for reinsurance recoverables on paid losses and loss adjustment
expenses as of December 31, 2001. NAICO is currently engaged in arbitration
in order to enforce the terms of the reinsurance treaties.
Reliance Insurance Company ("Reliance") reinsured NAICO for certain
workers compensation risks during 1998 and 1999. During the fourth quarter of
1999, NAICO and Reliance rescinded two reinsurance treaties which had been in
effect since January 1, 1999. NAICO received a return of ceded premiums and
reassumed certain losses as a result of the rescission. At December 31, 2001,
NAICO had reinsurance recoverables from Reliance for paid and unpaid losses
relating to the 1998 treaties of approximately $2.2 million. During October
2001, the Commonwealth of Pennsylvania placed Reliance in liquidation. At
this time, NAICO is unable to determine the amount of its reinsurance
recoverables from Reliance that will ultimately be collected.
Reinsurance contracts do not relieve an insurer from its obligation to
policyholders. Failure of reinsurers to honor their obligations could result
in losses to Chandler USA; consequently, adjustments to ceded losses and loss
adjustment expenses are made for amounts deemed uncollectible. NAICO did not
incur any charges for uncollectible reinsurance recoverables from reinsurers
in 1999 or 2000. During 2001, NAICO incurred charges of $454,000 in
adjustments to ceded losses and loss adjustment expenses for amounts deemed
uncollectible, and has reduced the carrying value of such amounts by
approximately $1.1 million as of December 31, 2001.
PAGE 6
LOSS AND UNDERWRITING EXPENSE RATIOS
The combined loss and underwriting expense ratio ("Combined Ratio") is
the traditional measure of underwriting experience for property and casualty
insurance companies. It is the sum of the ratios of (i) incurred losses and
loss adjustment expenses to net premiums earned ("loss ratio") and (ii)
underwriting expenses to net premiums written and assumed ("underwriting
expense ratio").
The following table shows the underwriting experience of Chandler USA for
the periods indicated by line of insurance written. Adjustments to reserves
made in subsequent periods are reflected in the year of adjustment. In the
following table, incurred losses include paid losses and loss adjustment
expenses, net changes in case reserves for losses and loss adjustment expenses
and net changes in reserves for incurred but not reported losses and loss
adjustment expenses. See also "Reserves" and "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS."
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1997 1998 1999 2000 2001
---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
Other liability:
Net premiums earned ................... $ 10,014 $ 11,357 $ 15,785 $ 20,992 $ 17,470
Loss ratio ............................ 47% 66% 70% 56% 57%
Workers compensation (1):
Net premiums earned ................... $ 35,646 $ 9,937 $ 29,244 $ 21,161 $ 16,449
Loss ratio ............................ 72% 66% 77% 70% 105%
Automobile liability:
Net premiums earned ................... $ 13,704 $ 11,419 $ 15,027 $ 17,517 $ 13,386
Loss ratio ............................ 76% 75% 78% 78% 70%
Automobile physical damage:
Net premiums earned ................... $ 5,726 $ 4,702 $ 7,039 $ 11,434 $ 12,174
Loss ratio ............................ 60% 86% 104% 85% 52%
Property:
Net premiums earned ................... $ 1,912 $ 2,332 $ 2,972 $ 3,377 $ 4,806
Loss ratio ............................ 74% 136% 203% 179% 93%
Surety:
Net premiums earned ................... $ 10,671 $ 7,619 $ 8,061 $ 6,760 $ 4,125
Loss ratio ............................ 8% 18% 6% 33% 57%
Inland marine:
Net premiums earned ................... $ 500 $ 448 $ 775 $ 1,088 $ 1,256
Loss ratio ............................ 196% 126% 138% 142% 143%
Accident and health:
Net premiums earned ................... $ 2,529 $ 4,610 $ 8,195 $ 3,190 $ 319
Loss ratio ............................ 43% 91% 104% 161% 281%
Total (1):
Net premiums earned ................... $ 80,702 $ 52,424 $ 87,098 $ 85,519 $ 69,985
Loss ratio ............................ 60% 69% 79% 76% 75%
Underwriting expense ratio (2) ........ 38% 33% 32% 30% 33%
---------- ---------- ---------- ---------- ----------
Combined ratio (2) .................... 98% 102% 111% 106% 108%
========== ========== ========== ========== ==========
- -----------------------------------------
(1) The rescission of two reinsurance treaties during 1999 increased net premiums earned for
workers compensation by $19.6 million and increased the workers compensation loss ratio
by 20 percentage points. The rescission of the reinsurance treaties also increased the
total 1999 loss ratio by 2 percentage points and the 1999 combined ratio by 4 percentage
points.
(2) Interest expense and litigation expenses are not considered underwriting expenses;
therefore, such costs have been excluded from these ratios.
PAGE 7
RESERVES
Insurance companies provide in their financial statements reserves for
unpaid losses and loss adjustment expenses which are estimates of the expense
of investigation and settlement of all reported and incurred but not reported
losses under their previously issued insurance policies and/or reinsurance
contracts. In estimating reserves, insurance companies use various
standardized methods based on historical experience and payment and reporting
patterns for the type of risk involved. The application of these methods
involves subjective determinations by the personnel of the insurance company.
Inherent in the estimates of the ultimate liability for unpaid claims are
expected trends in claim severity, claim frequency and other factors that may
vary as claims are settled. The amount of and uncertainty in the estimates
is affected by such factors as the amount of historical claims experience
relative to the development period for the type of risk, knowledge of the
actual facts and circumstances and the amount of insurance risk retained.
The ultimate cost of insurance claims can be adversely affected by increased
costs, such as medical expenses, repair expenses, costs of providing legal
defense for policyholders, increased jury awards and court decisions and
legislation that expand insurance coverage after the insurance policy was
priced and sold. Accordingly, the loss and loss adjustment expense reserves
may not accurately predict an insurance company's ultimate liability for
unpaid claims.
NAICO periodically reviews the reserve estimates relating to insurance
business written or assumed by NAICO, and the methods used to arrive at such
reserve estimates. NAICO also retains independent professional actuaries who
review such reserve estimates and methods. Any changes in the estimates are
reflected in current operating results. Salvage and subrogation recoverables
are accrued using the "case basis" method for large recoverables and
statistical estimates based on historical experience for smaller
recoverables. Recoverable amounts deducted from Chandler USA's net liability
for losses and loss adjustment expenses were approximately $3.5 million and
$5.0 million at December 31, 2000 and 2001, respectively. NAICO's
statutory-based reserves (reserves calculated in accordance with an
insurer's domiciliary state insurance regulatory authorities) do not differ
from its reserves reported on the basis of generally accepted accounting
principles ("GAAP"). NAICO does not discount its reserves for unpaid losses
or loss adjustment expenses.
NAICO participates in various pools covering workers compensation risks
for insureds who were unable to purchase this coverage from an insurance
company on a voluntary basis. In addition, NAICO receives direct assignments
to write workers compensation for such insureds in lieu of participating in
the pools. The consolidated financial statements reflect the reserves for
unpaid losses and loss adjustment expenses and net premiums earned from its
participation in the pools and from these direct assignments.
There may be significant reporting lags between the occurrence of the
insured loss and the time it is actually reported to the insurer. The
inherent uncertainties in estimating insurance reserves are generally greater
for casualty coverages, such as workers compensation, general and automobile
liability, than for property coverages primarily due to the longer period of
time that typically elapses before a definitive determination of ultimate
loss can be made, which is also affected by changing theories of legal
liability and changing political climates.
There are significant additional uncertainties in estimating the amount
of reserves required for environmental, asbestos-related and other latent
exposure claims, including a lack of historical data, long reporting delays
and complex unresolved legal issues regarding policy coverage and the extent
and timing of any such contractual liability. Courts have reached different
and frequently inconsistent conclusions as to when the loss occurred, what
claims are covered, under what circumstances the insurer has an obligation to
defend, how policy limits are determined and how policy exclusions are applied
and interpreted.
The loss settlement period on insurance claims for property damage is
relatively short. The more severe losses for bodily injury and workers
compensation claims have a much longer loss settlement period and may be paid
out over several years. It is often necessary to adjust estimates of
liability on a loss either upward or downward from the time a claim arises to
the time of payment. Workers compensation indemnity benefit reserves are
determined based on statutory benefits described by state law and are
estimated based on the same factors generally discussed above which may
include, where state law permits, inflation adjustments for rising benefits
over time. Generally, the more costly automobile liability claims involve
one or more severe bodily injuries or deaths. The ultimate cost of these
types of claims is dependent on various factors including the relative
liability of the parties involved, the number and severity of injuries and the
legal jurisdiction where the incident occurred.
PAGE 8
The following table sets forth a reconciliation of the beginning and
ending reserves for losses and loss adjustment expenses which are net of
reinsurance deductions for the years indicated.
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1997 1998 1999 2000 2001
---------- ---------- ---------- ---------- ----------
(In thousands)
Net balance before provision for uncollectible
reinsurance at beginning of year ............. $ 53,313 $ 53,345 $ 39,570 $ 51,123 $ 46,588
---------- ---------- ---------- ---------- ----------
Net losses and loss adjustment expenses
incurred related to:
Current year ............................ 46,645 34,313 65,139 60,020 39,881
Prior years ............................. 1,868 1,737 3,520 4,979 12,669
---------- ---------- ---------- ---------- ----------
Total .............................. 48,513 36,050 68,659 64,999 52,550
---------- ---------- ---------- ---------- ----------
Net paid losses and loss adjustment expenses
related to:
Current year ............................ (19,909) (19,495) (33,210) (33,525) (22,596)
Prior years ............................. (28,572) (30,330) (23,896) (36,009) (43,799)
---------- ---------- ---------- ---------- ----------
Total .............................. (48,481) (49,825) (57,106) (69,534) (66,395)
---------- ---------- ---------- ---------- ----------
Net balance before provision for uncollectible
reinsurance at end of year ................... 53,345 39,570 51,123 46,588 32,743
Adjustments to reinsurance recoverables on
unpaid losses for uncollectible reinsurance... 690 351 255 119 69
---------- ---------- ---------- ---------- ----------
Net balance at end of year ........................ $ 54,035 $ 39,921 $ 51,378 $ 46,707 $ 32,812
========== ========== ========== ========== ==========
During 2001, NAICO experienced adverse loss development related to prior
accident years totaling $12.7 million. This adverse loss development was due
primarily to increased loss severity in the standard property and casualty and
political subdivisions programs. A substantial part of this loss development
was for workers compensation losses in the 1999 accident year. NAICO's net
retention for workers compensation losses increased substantially in 1999 due
to the rescission of certain reinsurance treaties covering this line of
business. Also contributing to the adverse loss development were provisions
for potentially uncollectible reinsurance and deductibles of approximately
$1.2 million during 2001, an increase in losses in the surety bond program and
approximately $878,000 in losses for the runoff of the discontinued group
accident and health program.
The following table represents the development of net balance sheet
reserves for 1992 through 2001. The top line of the table shows the net
reserves at the balance sheet date for each of the indicated years. This
represents the estimated amounts of claims and claim expenses, net of
reinsurance deductions, arising in the current and all prior years that are
unpaid at the balance sheet date, including the net reserve for incurred but
not reported claims. The upper portion of the table shows the cumulative net
amounts paid as of successive years with respect to that reserve liability.
The estimate for unpaid losses and loss adjustment expenses changes as more
information becomes known about the frequency and severity of claims for
individual years. The next portion of the table shows the revised estimated
amount of the previously recorded net reserve based on experience as of the
end of each succeeding year. The heading "net cumulative (deficiency)
redundancy" represents the cumulative aggregate change in the estimates over
all prior years. The last portion of the table provides a reconciliation of
the net amounts to the gross amounts before any deductions for reinsurance.
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 1995 for
claims that occurred in 1992 will be included in the cumulative deficiency
amount for years 1992, 1993, 1994 and 1995. 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.
PAGE 9
DEVELOPMENT OF RESERVES
AS OF DECEMBER 31,
-------------------------------------------------------------------------------------------------------------
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
---------- ----------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------
(In thousands)
Net reserve for unpaid
losses and loss
adjustment
expenses (1).........$ 46,604 $ 51,648 $ 64,308 $ 58,340 $ 53,845 $ 54,035 $ 39,921 $ 51,378 $ 46,707 $ 32,812
Net paid (cumulative)
as of
One year later ...... 26,849 26,469 30,771 31,768 28,572 30,330 23,896 36,009 43,799
Two years later ..... 39,770 38,655 45,321 44,471 40,857 42,934 34,966 58,979
Three years later ... 46,360 45,357 51,985 49,262 45,668 49,735 45,390
Four years later .... 49,400 48,385 54,825 51,101 47,995 56,306
Five years later .... 51,299 49,116 55,691 52,126 50,700
Six years later ..... 51,641 49,399 56,278 54,040
Seven years later ... 51,867 49,681 57,826
Eight years later ... 52,071 50,291
Nine years later .... 52,652
Net liability
re-estimated as of (1)
One year later ...... 51,951 52,058 62,757 59,644 55,713 55,772 43,441 56,357 59,376
Two years later ..... 50,845 50,135 61,924 59,605 55,599 56,362 45,373 67,469
Three years later ... 51,076 50,492 62,737 59,155 54,528 58,176 50,146
Four years later .... 51,572 51,022 62,636 58,247 54,834 61,096
Five years later .... 52,309 50,981 62,195 58,445 55,615
Six years later ..... 52,275 50,954 62,295 58,567
Seven years later ... 52,381 50,832 62,630
Eight years later ... 52,315 50,932
Nine years later .... 52,421
Net cumulative (deficiency)
redundancy ..........$ (5,817) $ 716 $ 1,678 $ (227) $ (1,770) $ (7,061) $ (10,225) $ (16,091) $ (12,669) $ -
Supplemental gross data:
Gross liability after
reclassification of
pools - end
of year ...........$ 210,892 $ 167,187 $ 143,437 $ 116,149 $ 78,114 $ 73,721 $ 80,701 $ 98,460 $ 100,173 $ 84,756
Reclassification of
pool liabilities .. (18,875) (15,694) - - - - - - - -
---------- ----------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------
Gross liability
before reclassification
of pools - end
of year (1) .......$ 192,017 $ 151,493 $ 143,437 $ 116,149 $ 78,114 $ 73,721 $ 80,701 $ 98,460 $ 100,173 $ 84,756
Reinsurance
recoverable ....... 145,413 99,845 79,129 57,809 24,269 19,686 40,780 47,082 53,466 51,944
---------- ----------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------
Net liability - end
of year (1) .......$ 46,604 $ 51,648 $ 64,308 $ 58,340 $ 53,845 $ 54,035 $ 39,921 $ 51,378 $ 46,707 $ 32,812
========== =========== ========== ========== ========== ========== ========== ========== ========== =========
Gross re-estimated
liability -
latest ............$ 193,200 $ 148,369 $ 142,547 $ 119,678 $ 92,050 $ 92,121 $ 110,647 $ 141,658 $ 137,507
Re-estimated recoverable -
latest ............ 140,779 97,437 79,917 61,111 36,435 31,025 60,501 74,189 78,131
---------- ----------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Net re-estimated liability -
latest (1) ........$ 52,421 $ 50,932 $ 62,630 $ 58,567 $ 55,615 $ 61,096 $ 50,146 $ 67,469 $ 59,376
========== =========== ========== ========== ========== ========== ========== ========== ==========
Gross cumulative (deficiency)
redundancy ........$ (1,183) $ 3,124 $ 890 $ (3,529) $ (13,936) $ (18,400) $ (29,946) $ (43,198) $ (37,334)
========== =========== ========== ========== ========== ========== ========== ========== ==========
- --------------------------------------------
(1) The December 31, 1993 and prior amounts do not include the reclassification of pool liabilities.
PAGE 10
INVESTMENTS
Funds available for investment include Chandler USA's present capital as
well as premiums received and retained under insurance policies and
reinsurance agreements issued by NAICO. Until these funds are required to be
used for the settlement of claims and the payment of operating expenses, they
are invested with the objective of generating income, preserving principal and
maintaining liquidity.
Fixed-maturity investments are purchased to support the investment
strategies of Chandler USA and its subsidiaries, which are developed based on
many factors including rate of return, maturity, credit risk, tax
considerations, regulatory requirements and their mix of business. At the
time of purchase, investments in debt securities that Chandler USA has the
positive intent and ability to hold to maturity are classified as held to
maturity and reported at amortized cost; all other debt securities are
reported at fair value. Investments classified as trading are actively and
frequently bought and sold with the objective of generating income on
short-term differences in price. Realized and unrealized gains and losses
on securities classified as trading account assets are recognized in current
operations. Chandler USA has not classified any investments as trading
account assets. Securities not classified as held to maturity or trading are
classified as available for sale, with the related unrealized gains and
losses excluded from earnings and reported net of deferred income tax as a
separate component of other comprehensive income until realized. Realized
gains and losses on sales of securities are based on the specific
identification method. Declines in the fair value of investment securities
below their carrying value that are other than temporary are recognized in
earnings.
As of December 31, 2001, all of the investments of NAICO were in
fixed-maturity investments (rated Aa3 or A- or better by Moody's Investors
Service, Inc. or Standard & Poor's, respectively), interest-bearing money
market accounts, a collateralized repurchase agreement and common stock
received in connection with two unaffiliated entities' conversion to
for-profit corporations. A substantial portion of NAICO's investment
portfolio was managed by Madison Scottsdale, L.C. during 2000 and 2001.
NAICO terminated the relationship with Madison Scottsdale, L.C. effective
December 31, 2001, and the investment portfolio is currently managed by the
Investment Committee of its Board of Directors. For additional information,
see Notes to Consolidated Financial Statements.
DEBENTURES
On July 16, 1999, Chandler USA completed a public offering of $24 million
principal amount of senior debentures with a maturity date of July 16, 2014.
The debentures were priced at $1,000 each with an interest rate of 8.75% and
are redeemable by Chandler USA on or after July 16, 2009 without penalty or
premium. The proceeds to Chandler USA before expenses but after the
underwriter's discount were $23.16 million. The proceeds of the offering were
used to repay existing bank debt, to repay amounts owed by Chandler USA to
Chandler Barbados, and for general corporate purposes. Chandler USA's
subsidiaries and affiliates are not obligated by the debentures. Accordingly,
the debentures are effectively subordinated to all existing and future
liabilities and obligations of Chandler USA's existing and future subsidiaries.
EMPLOYEES AND ADMINISTRATION
At December 31, 2001, Chandler USA and its subsidiaries had approximately
375 full-time employees. Chandler USA and its subsidiaries generally have
enjoyed good relations with their employees.
COMPETITION
NAICO operates in a highly competitive industry and faces competition
from domestic and foreign insurers, many of which are larger, have greater
financial, marketing and management resources, have more favorable ratings by
ratings agencies and offer more diversified insurance coverages than NAICO.
A company's capacity to write insurance policies is dependent on a
variety of factors including its net worth or "surplus," the lines of
business written, the types of risk insured and its profitability. Since
the late 1980's, the industry has generally had excess underwriting capacity.
This condition resulted in depressed premium rates and expanded policy terms,
which generally occur when excess underwriting capacity exists. NAICO
continues to experience competition, however, NAICO was able to increase its
pricing for most coverages during 2000 and 2001, which has generally been the
trend industry wide. NAICO's underwriting philosophy is to forego
underwriting risks from which it is unable to obtain what it believes to be
adequate premium rates.
PAGE 11
REGULATION
REGULATION IN GENERAL
NAICO is subject to regulation by government agencies in the
jurisdictions in which it does business. The nature and extent of such
regulation vary from jurisdiction to jurisdiction, but typically involve
prior approval of the acquisition of control of an insurance company or of any
company controlling an insurance company, regulation of certain transactions
entered into by an insurance company with any of its affiliates, approval of
premium rates, forms and policies used for many lines of insurance, standards
of solvency and minimum amounts of capital and surplus which must be
maintained, establishment of reserves required to be maintained for unearned
premiums, unpaid losses and loss adjustment expenses or for other purposes,
limitations on types and amounts of investments, restrictions on the size of
risks which may be insured by a single company, licensing of insurers and
agents, deposits of securities for the benefit of policyholders and the filing
of periodic reports with respect to financial condition and other matters. In
addition, regulatory examiners perform periodic financial and market conduct
examinations of insurance companies. Such regulation is generally intended for
the protection of policyholders rather than shareholders or creditors.
NAICO is required to deposit securities with regulatory agencies in
several states in which it is licensed as a condition of conducting operations
in those states.
In addition to the regulatory oversight of NAICO, Chandler Insurance is
also subject to regulation under the laws of the Cayman Islands and Chandler
USA and all of its affiliates are subject to regulation under the insurance
laws of Oklahoma (the "Oklahoma Insurance Code"). The Oklahoma Insurance Code
contains certain reporting requirements including those requiring Chandler
Insurance, as the ultimate parent company, to file information relating to its
capital structure, ownership, and financial condition and the general business
operations of its insurance subsidiaries. The Oklahoma Insurance Code contains
special reporting and prior approval requirements with respect to transactions
among affiliates.
NAICO is also affected by a variety of state and federal legislative and
regulatory measures and judicial decisions that define and extend the risks
and benefits for which insurance is sought and provided. These include
redefinitions of risk exposure in areas such as product liability,
environmental damage and workers compensation. In addition, individual state
insurance departments may prevent premium rates for some classes of insureds
from reflecting the level of risk assumed by the insurer for those classes.
Such developments may adversely affect the profitability of various lines of
insurance. In some cases, these adverse effects on profitability can be
minimized through re-pricing, if permitted by applicable regulations, of
coverages or limitations or cessation of the affected business.
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 Oklahoma Insurance Code. The Oklahoma Insurance Code provides that
the acquisition or change of "control" of a domestic insurer or of any person
that controls a domestic insurer cannot be consummated without the prior
approval of the Oklahoma Department of Insurance. A person seeking to acquire
control, directly or indirectly, of a domestic insurance company or of any
person controlling a domestic insurance company must generally file with the
relevant insurance regulatory authority an application for change of control
containing certain information required by statute and published regulations
and provide a copy of such to the domestic insurer. In Oklahoma, control is
generally presumed to exist if any person, directly or indirectly, owns,
controls, holds with the power to vote or holds proxies representing 10% or
more of the voting securities of the insurance company or of any other person
or entity controlling the insurance company. The 10% presumption is not
conclusive and control may be found to exist at less than 10%.
In addition, many state insurance regulatory laws contain provisions that
require pre-notification to state agencies of a change in control of a
non-domestic insurance company admitted in that state. While such
pre-notification statutes do not authorize the state agency to disapprove the
change of control, such statutes do authorize issuance of a cease and desist
order with respect to the non-domestic insurer if certain conditions exist
such as undue market concentration.
PAGE 12
Any future transactions that would constitute a change in control of
Chandler Insurance, Chandler Barbados or Chandler USA would also generally
require prior approval by the Oklahoma Department of Insurance and would
require pre-acquisition notification in those states which have adopted
pre-acquisition notification provisions and in which the insurers are
admitted. Because such requirements are primarily for the benefit of
policyholders, they may deter, delay or prevent certain transactions that
could be advantageous to the shareholders or creditors of Chandler USA. The
Oklahoma Department of Insurance approved the change of control resulting from
the going private transaction for Chandler Insurance during 2001.
RESTRICTIONS ON SHAREHOLDER DIVIDENDS
A significant portion of Chandler USA's consolidated assets represents
assets of NAICO that may not be immediately transferable to Chandler USA in
the form of shareholder dividends, loans, advances or other payments.
Statutes and regulations governing NAICO and other insurance companies
domiciled in Oklahoma regulate the payment of shareholder dividends and other
payments by NAICO to Chandler USA. Under applicable Oklahoma statutes and
regulations, NAICO is permitted to pay shareholder dividends only out of
statutory earned surplus. To the extent NAICO has statutory earned surplus,
NAICO may pay shareholder dividends only to the extent that such dividends are
not defined as extraordinary dividends or distributions. If the dividends
are, under applicable statutes and regulations, extraordinary dividends or
distributions, regulatory approval must be obtained. Under the applicable
Oklahoma statute, and subject to the availability of statutory earned surplus,
the maximum shareholder dividend that may be declared (or cash or property
distribution that may be made) by NAICO in any one calendar year without
regulatory approval is the greater of (i) NAICO's statutory net income,
excluding realized capital gains, for the preceding calendar year; or (ii) 10%
of NAICO's statutory policyholders' surplus as of the preceding calendar year
end, not to exceed NAICO's statutory earned surplus.
As of December 31, 2001, NAICO had statutory earned surplus of
$16.4 million. Applying the Oklahoma statutory limits described above, the
maximum shareholder dividend NAICO may pay in 2002 without the approval of
the Oklahoma Department of Insurance is $4.9 million. NAICO paid shareholder
dividends totaling $7.0 million and $2.5 million to Chandler USA in 2001 and
2000, respectively. The Oklahoma Department of Insurance approved the payment
of the extraordinary dividend by NAICO to Chandler USA in 2001.
In addition to the statutory limits described above, the amount of
shareholder dividends and other payments to affiliates permitted can be
further limited by contractual or regulatory restrictions or other agreements
with regulatory authorities restricting dividends and other payments,
including regulatory restrictions that are imposed as a matter of
administrative policy. If insurance regulators determine that payment of a
shareholder dividend or other payments to an affiliate (such as payments under
a tax sharing agreement, payments for employee or other services, or payments
pursuant to a surplus note) would be hazardous to such insurance company's
policyholders or creditors, the regulators may block such payments that would
otherwise be permitted without prior approval.
RISK-BASED CAPITAL
The National Association of Insurance Commissioners has adopted a
methodology for assessing the adequacy of statutory surplus of domestic
property and casualty insurers. This methodology is described in the Risk
Based Capital Model Act (the "RBC Model Act"). The RBC Model Act includes a
risk-based capital requirement that requires insurance companies to calculate
and report information under a risk-based formula which attempts to measure
statutory capital and surplus needs based on the risks in the insurance
company's mix of products and investment portfolio. The formula is designed
to allow state insurance regulators to identify potential under-capitalized
companies. Under the formula, an insurer determines its "risk-based capital"
("RBC") by taking into account certain risks related to the insurer's assets
(including risks related to its investment portfolio and ceded reinsurance)
and the insurer's liabilities (including underwriting risks related to the
nature and experience of its insurance business). The RBC rules provide for
different levels of regulatory attention depending on the ratio of a company's
total adjusted capital to its "authorized control level" of RBC. Insurers
below the specific ratios are classified within certain levels, each of which
requires specific corrective action. The levels and ratios are as follows:
PAGE 13
Ratio of Total Adjusted Capital to
Authorized Control Level RBC
(Less than or equal to)
------------------------------------
Regulatory Event (1)
--------------------
Company Action Level (2)............ 2.0
Regulatory Action Level (3)......... 1.5
Authorized Control Level (4)........ 1.0
Mandatory Control Level (5)......... 0.7
- ------------------------------------
(1) When an insurer's ratio exceeds 2.0, it is not subject to regulatory attention under
the RBC Model Act.
(2) "Company Action Level" requires an insurer to prepare and submit an RBC Plan to the
insurance commissioner of its state of domicile. After review, the insurance commissioner
will notify the insurer if the Plan is satisfactory.
(3) "Regulatory Action Level" requires the insurer to submit an RBC Plan, or if applicable,
a Revised RBC Plan to the insurance commissioner of its state of domicile. After
examination or analysis, the insurance commissioner will issue an order specifying
corrective actions to be taken.
(4) "Authorized Control Level" authorizes the insurance commissioner to take such regulatory
actions considered necessary to protect the best interest of the policyholders and
creditors of an insurer which may include the actions necessary to cause the insurer to be
placed under regulatory control (i.e., rehabilitation or liquidation).
(5) "Mandatory Control Level" authorizes the insurance commissioner to take actions necessary
to place the insurer under regulatory control (i.e., rehabilitation or liquidation).
The ratios of total adjusted capital to authorized control level RBC for NAICO
were 5.2:1 and 6.6:1 at December 31, 2000 and 2001, respectively. Therefore,
NAICO's total adjusted capital exceeds the level that would trigger regulatory
attention pursuant to the risk-based capital requirement.
NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS-IRIS RATIOS
The National Association of Insurance Commissioners Insurance Regulatory
Information System ("IRIS") was developed by a committee of state insurance
regulators and is primarily intended to assist state insurance departments in
executing their statutory mandates to oversee the financial condition of
insurance companies operating in their respective states. IRIS identifies 12
industry ratios and specifies "usual values" for each ratio. Departure from
the "usual values," which fluctuate annually, on four or more ratios generally
leads to inquiries from individual state insurance commissioners. NAICO had
six 2001 ratios that were outside of the "usual values," four of which
resulted primarily from adverse loss development as explained below.
NAICO's "surplus aid to policyholders' surplus" ratio for 2001 was 16%
compared to a usual value of less than 15%. This was due primarily to ceding
commissions from the purchase of additional quota share reinsurance that was
in effect during 2001. This quota share reinsurance expired effective
January 1, 2002 and NAICO elected not to renew it.
NAICO's "two-year overall operating ratio" for 2001 was 100% compared to
a usual value of less than 100%. Factors that contributed to NAICO's ratio
include a decrease in the ratio of investment income to net premiums earned
due primarily to lower interest rates experienced during 2001, and to adverse
loss development recorded during 2000 and 2001 for accident years prior to
2000. Excluding this loss development, the two-year overall operating ratio
would have been 97% for 2001.
NAICO's "investment yield" as calculated using the IRIS formula was 2.7%
during 2001 compared to a usual value of greater than 4.5% and less than
10.00%. NAICO maintains a high-quality investment portfolio, with no
non-investment grade bonds or real estate investments. NAICO's investment
yield is largely dependent upon prevailing levels of interest rates. The
decline in interest rates during 2001 had a significant impact on NAICO's
investment yield. During 2001, NAICO incurred $997,000 in investment expenses
to subsidize a premium finance program for certain insureds of NAICO. While
such expenses reduced NAICO's investment yield, the premium finance program
enhances cash flow by providing cash which is available for investment earlier
than conventional deferred payment plans. Excluding the investment expenses
for this premium finance program, NAICO's investment yield would have been
3.7% for 2001.
PAGE 14
NAICO's "one-year reserve development to policyholders' surplus" and
"two-year reserve development to policyholders' surplus" for 2001 were 24%
and 35%, respectively, compared to usual values of less than 20% for both
ratios. The primary reason for these unusual values was adverse loss
development experienced during 2001 related to prior accident years. This
adverse loss development was due primarily to increased loss severity in the
standard property and casualty and political subdivisions programs. A
substantial part of this loss development was for workers compensation losses
in the 1999 accident year. NAICO's net retention for workers compensation
losses increased substantially in 1999 due to the rescission of certain
reinsurance treaties covering this line of business. Also contributing to
the adverse loss development, as calculated using the IRIS formula, were
provisions for potentially uncollectible reinsurance and deductibles of
approximately $888,000 during 2001, an increase in losses in the surety bond
program and approximately $878,000 in losses for the runoff of the
discontinued group accident and health program.
NAICO's "estimated current reserve deficiency to policyholders' surplus"
was 36% at December 31, 2001 compared to a usual value of less than 25%. The
adverse loss development experienced in 2001 related to prior accident years
was primarily responsible for this ratio being outside of the normal range.
The calculation of this ratio assumes that factors that led to past under
reserving will cause current under reserving without regard to changes in
premium volume, premium rates, product mix, the amount of risk retained by
NAICO and current reserving practices. See "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" and "Reinsurance."
CODIFICATION
In 1998, the National Association of Insurance Commissioners adopted
codified statutory accounting principles ("Codification"). Codification
changed, to some extent, prescribed statutory accounting practices and
resulted in changes to the accounting practices that NAICO uses to prepare
its statutory financial statements. The State of Oklahoma adopted
Codification to be effective January 1, 2001. The adoption of Codification
increased NAICO's statutory policyholders' surplus by $3.5 million as of
January 1, 2001 which resulted primarily from the recognition of a net
deferred tax asset.
EFFECT OF FEDERAL LEGISLATION
Although the federal government does not directly regulate the business
of insurance, federal initiatives often affect the insurance business in a
variety of ways. Current and proposed federal measures which may
significantly affect the insurance business include federal government
participation in asbestos and other product liability claims, claims related
to acts of terrorism, pension and other employee benefit plan regulation
(ERISA), examination of the taxation of insurers and reinsurers, minimum
levels of liability insurance and automobile safety regulations. Federal
regulation of the health care industry may directly and indirectly impact the
business of insurance.
ITEM 2. PROPERTIES
Chandler USA and its subsidiaries own and occupy four office buildings
with approximately 127,000 square feet of usable space in Chandler, Oklahoma.
Chandler USA's subsidiaries also lease approximately 3,800 square feet in the
aggregate for its branch offices. Chandler USA believes such space is
sufficient for its operations for the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
CENTRA LITIGATION
Chandler Insurance and certain of its subsidiaries and affiliates have
been involved in litigation with CenTra, Inc. ("CenTra") and certain of its
affiliates, officers and directors (the "CenTra Group") since July 1992. See
Note 9 to Consolidated Financial Statements for a detailed discussion. See
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CenTra Litigation."
GOING PRIVATE LITIGATION
On June 5 and 6, 2000, three civil lawsuits were filed against Chandler
Insurance, Chandler USA and all of Chandler Insurance's directors. All three
suits were consolidated into a single proceeding. The suit alleged that the
plans announced on June 1, 2000 to take Chandler Insurance private are
detrimental to certain shareholders of Chandler Insurance that would be
subject to a reverse stock split. Each suit also requested that it be
certified as a class action and that the court enter a temporary restraining
order to prevent completion of the announced plan. The suit also alleged that
all defendants have breached and are breaching fiduciary duties owed to the
plaintiffs and other shareholders. In March 2001, Chandler Insurance
completed the going private transaction. See Note 13 to Consolidated
Financial Statements. On October 5, 2001, the suits were dismissed.
OTHER LITIGATION
Chandler USA and its subsidiaries are not parties to any other material
litigation other than as is routinely encountered in their respective business
activities.
PAGE 15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
quarter ended December 31, 2001.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
All of the common stock of Chandler USA, its sole class of common equity
on the date hereof, is owned by Chandler Barbados, which is a wholly owned
subsidiary of Chandler Insurance. See "Item 1. BUSINESS - Going Private
Transaction - Parent Company." Chandler USA has never paid cash dividends on
its common shares.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data has been derived from the consolidated
financial statements of Chandler USA and its subsidiaries, which appear in
Item 14(a). The consolidated balance sheets of Chandler USA and its
subsidiaries as of December 31, 2000, and the related consolidated statements
of operations, comprehensive income, shareholder's equity and cash flows for
each of the two years in the period ended December 31, 2000 were audited by
Deloitte & Touche LLP, independent auditors, whose independent auditors'
report expressed an unqualified opinion and included an explanatory paragraph
relating to litigation. The consolidated balance sheet of Chandler USA and
its subsidiaries as of December 31, 2001 and the related consolidated
statements of operations, comprehensive income, shareholder's equity and cash
flows for the year ended December 31, 2001 have been audited by Tullius Taylor
Sartain & Sartain LLP, 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 Chandler USA and the notes thereto appearing in Item
14(a). See Notes to Consolidated Financial Statements for various litigation
and contingency matters.
PAGE 16
ITEM 6. SELECTED FINANCIAL DATA (CONTINUED)
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
1997 1998 1999 2000 2001
---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
OPERATING DATA
Revenues
Direct premiums written and assumed .............. $ 123,088 $ 134,293 $ 169,569 $ 197,196 $ 158,964
========== ========== ========== ========== ==========
Net premiums earned .............................. $ 80,702 $ 52,424 $ 87,098 $ 85,519 $ 69,985
Interest income, net ............................. 6,130 4,904 3,959 4,335 3,700
Interest income, net from related parties......... - - - - 371
Realized investment gains, net ................... 790 1,036 57 144 2,654
Fee for rescinded reinsurance treaties ........... - - 10,000 - -
Commissions, fees and other income ............... 2,345 1,744 1,481 1,409 1,784
---------- ---------- ---------- ---------- ----------
Total revenues ..................................... 89,967 60,108 102,595 91,407 78,494
---------- ---------- ---------- ---------- ----------
Operating expenses
Losses and loss adjustment expenses .............. 48,513 36,050 68,659 64,999 52,550
Policy acquisition costs ......................... 22,819 10,685 21,160 17,155 10,949
General and administrative expenses .............. 11,984 11,277 10,795 12,398 13,775
Interest expense ................................. 442 887 1,496 2,255 2,240
Litigation expenses, net ......................... 923 423 207 71 65
---------- ---------- ---------- ---------- ----------
Total operating expenses ........................... 84,681 59,322 102,317 96,878 79,579
---------- ---------- ---------- ---------- ----------
Income (loss) before income taxes .................. 5,286 786 278 (5,471) (1,085)
Federal income tax benefit (provision) ............. (2,281) (353) (365) 1,476 (18)
---------- ---------- ---------- ---------- ----------
Net income (loss) .................................. $ 3,005 $ 433 $ (87) $ (3,995) $ (1,103)
========== ========== ========== ========== ==========
Combined loss and underwriting expense ratio (1).... 98% 102% 111% 106% 108%
BALANCE SHEET DATA
Cash and investments ............................... $ 107,957 $ 94,947 $ 93,666 $ 104,760 $ 73,378
Amounts due from related parties ................... - - - - 7,880
Total assets ....................................... 202,787 223,351 256,836 273,498 234,809
Unpaid losses and loss adjustment expenses ......... 73,721 80,701 98,460 100,173 84,756
Notes payable ...................................... 2,796 9,410 - - -
Amounts due to related parties ..................... 19,918 12,219 533 717 -
Debentures ......................................... - - 24,000 24,000 24,000
Total liabilities .................................. 154,351 174,090 210,097 228,647 191,067
Shareholder's equity ............................... 48,436 49,261 46,739 44,851 43,742
- ------------------------------------------------------
(1) Interest expense and litigation expenses are not considered underwriting expenses; therefore, such expenses have
been excluded from this ratio. The rescission of two reinsurance treaties during 1999 increased the 1999 combined loss
and underwriting expense ratio by four percentage points. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS."
PAGE 17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
References to Chandler USA which follow within this Item 7 refer to
Chandler USA and its subsidiaries on a consolidated basis unless otherwise
indicated.
Chandler USA is engaged in various property and casualty insurance
operations through its wholly owned subsidiaries, NAICO and L&W. NAICO writes
various property and casualty insurance products through three separate
marketing programs: standard property and casualty, political subdivisions
and surety bonds (including both bail bonds and construction bonds). The
lines of insurance written by NAICO are commercial coverages consisting of
automobile liability, workers compensation, surety, automobile physical
damage, property, inland marine and other liability lines, which include
general and professional liability lines. L&W represents various personal
and commercial lines insurance companies in marketing property and casualty
insurance. L&W also markets individual and group life, medical and disability
income coverage. L&W places a large portion of its business with NAICO.
Business produced by L&W and placed with NAICO constituted approximately 26%
of NAICO's direct premiums written and assumed in 2001.
Many factors determine the profitability of an insurance company
including regulation and rate competition; the frequency and severity of
claims; the cost, availability and collectibility of reinsurance; interest
rates; inflation; general business conditions; and jury awards, court
decisions and legislation expanding the extent of coverage and the amount of
compensation due for injuries and losses.
CLAIM COSTS AND LOSS RESERVES
Insurance companies provide in their financial statements reserves for
unpaid losses and loss adjustment expenses which are estimates of the expense
of investigation and settlement of all reported and incurred but not reported
losses under their previously issued insurance policies and reinsurance
contracts. In estimating reserves, insurance companies use various
standardized methods based on historical experience and payment and reporting
patterns for the type of risk involved. The application of these methods
necessarily involves subjective determinations by the personnel of the
insurance company. Inherent in the estimates of the ultimate liability for
unpaid claims are expected trends in claim severity, claim frequency and other
factors that may vary as claims are settled. The amount of and uncertainty in
the estimates is affected by such factors as the amount of historical claims
experience relative to the development period for the type of risk, knowledge
of the actual facts and circumstances, and the amount of insurance risk
retained. The ultimate cost of insurance claims can be adversely affected by
increased costs, such as medical expenses, repair expenses, costs of providing
legal defense for policyholders, increased jury awards and court decisions and
legislation that expand insurance coverage after the insurance policy was
priced and sold. Accordingly, the loss and loss adjustment expense reserves
may not accurately predict an insurance company's ultimate liability for
unpaid claims.
NAICO periodically reviews the reserve estimates relating to insurance
business written or assumed by NAICO and the methods used to arrive at such
reserve estimates. NAICO also retains independent professional actuaries who
review such reserve estimates and methods. Any changes in the estimates are
reflected in current operating results. See Notes to Consolidated Financial
Statements.
The loss settlement period on insurance claims for property damage is
relatively short. The more severe losses for bodily injury and workers
compensation claims have a much longer loss settlement period and may be paid
out over several years. It is often necessary to adjust estimates of
liability on a loss either upward or downward between the time a claim arises
and the time of payment. Workers compensation indemnity benefit reserves are
determined based on statutory benefits prescribed by state law and are
estimated based on the same factors generally discussed above which may
include, where state law permits, inflation adjustments for rising benefits
over time. Generally, the more costly automobile liability claims involve one
or more severe bodily injuries or deaths. The ultimate cost of these types of
claims is dependent on various factors including the relative liability of the
parties involved, the number and severity of injuries and the legal
jurisdiction where the incident occurred.
PAGE 18
NAICO does not ordinarily insure against environmental matters as that
term is commonly used. However, in some cases, regulatory filings made on
behalf of an insured can make NAICO directly liable to the regulatory
authority for property damage, which could include environmental pollution.
In those cases, NAICO ordinarily has recourse against the insured or the
surety bond principal for amounts paid. NAICO has insured certain trucking
companies and pest control operators who are required to provide proof of
insurance which in some cases assures payment for cleanup and restoration of
damage resulting from sudden and accidental release or discharge of
contaminants or other substances which may be classified as pollutants. NAICO
also provides surety bonds for construction contractors who use or have
control of such substances and for contractors who remove and dispose of
asbestos as a part of their contractual obligations.
NAICO also insures independent oil and gas producers who may purchase
coverage for the escape of oil, saltwater, or other substances which may be
harmful to persons or property, but may not generally be classified as
pollutants. NAICO maintains claims records which segregate this type of risk
for the purpose of evaluating environmental risk exposure. Based upon the
nature of such lines of business with NAICO's insureds, and current data
regarding the limited severity and infrequency of such matters, it appears
that potential environmental risks are not a significant portion of claim
reserves and therefore would not likely have a material adverse impact, if
any, on the financial condition of Chandler USA.
NAICO's statutory-based reserves (reserves calculated in accordance with
accounting practices prescribed or permitted by an insurer's domiciliary state
insurance regulatory authorities for purposes of financial reporting to
regulators) do not differ from its reserves reported on the basis of GAAP.
NAICO does not discount its reserves for unpaid losses and loss adjustment
expenses. See Notes to Consolidated Financial Statements.
ECONOMIC CONDITIONS
The impact of a recession on Chandler USA would depend on its duration
and severity. A prolonged downturn in the economy could result in decreased
demand for NAICO's insurance products and an increase in uncollectible
premiums and/or reinsurance recoverables. In addition, an economic downturn
could result in an increase in the number of insurance claims if insureds
decrease expenditures that promote safety. Much of NAICO's insurance business
is concentrated in the Southwest and Midwest areas of the United States.
Approximately $143 million, or 90%, of NAICO's direct written premiums in 2001
were in the states of Oklahoma and Texas. An economic downturn in these
states could have a significant adverse impact on Chandler USA. A recession
might also cause defaults on fixed-income securities owned by NAICO. During
2001, the market value of NAICO's available for sale investments increased by
$2.6 million due primarily to lower interest rates experienced during this
time. Management believes it has mitigated the impact of a recession by
employing conservative underwriting practices and strict credit policies and
maintaining a high-quality investment portfolio.
Periods of inflation have varying effects on Chandler USA and its
subsidiaries as well as other companies in the insurance industry. Inflation
contributes to higher claims and related costs and operating costs as well as
higher interest rates which generally provide for potentially higher interest
rates on investable cash flow and decreases in the market value of existing
fixed-income securities. Premium rates and commissions, however, are not
significantly affected by inflation since competitive forces generally control
such rates. NAICO's underwriting philosophy is to forego underwriting risks
from which it is unable to obtain what it believes to be adequate premium
rates.
REGULATION
NAICO is subject to regulation by government agencies in the
jurisdictions in which it does business. The nature and extent of such
regulations vary from jurisdiction to jurisdiction, but typically involve
prior approval of the acquisition of control of an insurance company or of
any company controlling an insurance company, regulation of certain
transactions entered into by an insurance company with any of its affiliates,
approval of premium rates, forms and policies used for many lines of
insurance, standards of solvency and minimum amounts of capital and surplus
which must be maintained, establishment of reserves required to be maintained
for unearned premiums, unpaid losses and loss adjustment expenses or for
other purposes, limitations on types and amounts of investments, restrictions
on the size of risks which may be insured by a single company, licensing of
insurers and agents, deposits of securities for the benefit of policyholders
and the filing of periodic reports with respect to financial condition and
other matters. In addition, regulatory examiners perform periodic examinations
of insurance companies. Such regulation is generally intended for the
protection of policyholders rather than shareholders or creditors.
As an Oklahoma corporation, NAICO and any person controlling NAICO,
directly or indirectly, are subject to the insurance laws of Oklahoma
including laws concerning the change or acquisition of control and payment of
shareholder and policyholder dividends by NAICO.
PAGE 19
In addition to the regulatory oversight of NAICO, Chandler Insurance is
also subject to regulation under the laws of the Cayman Islands and Chandler
USA and all of its affiliates are also subject to regulation under the
Oklahoma Insurance Code. The Oklahoma Insurance Code contains certain
reporting requirements including those requiring Chandler Insurance, as the
ultimate parent company, to file information relating to its capital
structure, ownership and financial condition and general business operations
of its insurance subsidiaries. The Oklahoma Insurance Code contains special
reporting and prior approval requirements with respect to transactions among
affiliates. The Oklahoma Insurance Code also imposes certain requirements
upon any person controlling or seeking to control an insurance company
domiciled in Oklahoma. Control is generally presumed to exist if any person,
directly or indirectly, owns, controls, holds with the power to vote or holds
proxies representing 10% or more of the voting securities of the insurance
company or of any other person or entity controlling the insurance company.
The 10% presumption is not conclusive and control may be found to exist at
less than 10%. Persons owning any securities of Chandler USA or Chandler
Insurance must comply with the Oklahoma Insurance Code. See "BUSINESS -
Regulation."
Insurance companies are also affected by a variety of state and federal
legislative and regulatory measures and judicial decisions that define and
extend the risks and benefits for which insurance is sought and provided.
These include the redefinition of risk exposure in areas such as product
liability, environmental damage and workers compensation. In addition,
individual state insurance departments may prevent premium rates for some
classes of insureds from reflecting the level of risk assumed by the insurer
for those classes. Such developments may adversely affect the profitability
of various lines of insurance. In some cases, these adverse effects on
profitability can be minimized through coverage repricing, if permitted by
applicable regulations, or limitations or cessation of the affected business.
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 resulted in depressed premium rates and expanded policy terms, which
generally occur when excess underwriting capacity exists. NAICO continues to
experience competition, however, NAICO was able to increase its pricing for
most coverages during 2000 and 2001, which has generally been the trend
industry wide. NAICO's underwriting philosophy is to forego underwriting
risks from which it is unable to obtain what it believes to be adequate
premium rates.
PAGE 20
ANALYSIS OF INSURANCE PROGRAM RESULTS OF OPERATIONS
The following tables summarize the net premiums earned and the financial
year (losses incurred and recognized by Chandler USA regardless of the year in
which the claim occurred) and accident year (losses incurred by Chandler USA
for a particular year regardless of the period in which Chandler USA
recognizes the costs) loss ratios (computed by dividing losses and loss
adjustment expenses by net premiums earned) in each of the years presented.
The first table is summarized by major insurance program and includes all
lines of insurance written in each program. The second table is summarized by
line of insurance written and includes all net premiums earned and net losses
and loss adjustment expenses incurred from all insurance programs for that
particular line:
YEAR ENDED DECEMBER 31,
-----------------------------------------
1999 2000 2001
----------- ----------- -----------
(Dollars in thousands)
INSURANCE PROGRAMS
- -----------------------------------------------
STANDARD PROPERTY AND CASUALTY
Net premiums earned ...................... $ 56,673 $ 62,823 $ 53,130
Financial year loss ratio ................ 81.3% 76.6% 71.0%
Accident year loss ratio ................. 88.2% 72.2% 56.4%
POLITICAL SUBDIVISIONS
Net premiums earned ...................... $ 14,320 $ 12,826 $ 12,534
Financial year loss ratio ................ 102.9% 80.6% 91.1%
Accident year loss ratio ................. 101.7% 89.5% 62.2%
SURETY BONDS
Net premiums earned ...................... $ 7,835 $ 6,467 $ 4,125
Financial year loss ratio ................ 4.0% 35.1% 56.7%
Accident year loss ratio ................. 13.8% 12.7% 46.5%
GROUP ACCIDENT AND HEALTH (1)
Net premiums earned ...................... $ 8,195 $ 3,190 $ 319
Financial year loss ratio ................ 104.7% 159.3% 274.8%
Accident year loss ratio ................. 107.8% 118.0% -%
OTHER
Net premiums earned ...................... $ 75 $ 213 $ (123)
Financial year loss ratio ................ (1,398.7)% (389.3)% (166.4)%
Accident year loss ratio ................. 105.5% 76.3% (160.1)%
TOTAL
Net premiums earned ...................... $ 87,098 $ 85,519 $ 69,985
Financial year loss ratio ................ 78.8% 76.0% 75.1%
Accident year loss ratio ................. 85.6% 72.0% 57.0%
- -----------------------------------------------
(1) The group accident and health program was discontinued during 2000.
PAGE 21
YEAR ENDED DECEMBER 31,
-----------------------------------------
1999 2000 2001
----------- ----------- -----------
(Dollars in thousands)
LINES OF INSURANCE
- -----------------------------------------------
OTHER LIABILITY
Net premiums earned ...................... $ 15,785 $ 20,992 $ 17,470
Financial year loss ratio ................ 70.0% 55.6% 57.4%
Accident year loss ratio ................. 64.7% 44.6% 44.4%
WORKERS COMPENSATION
Net premiums earned ...................... $ 29,244 $ 21,161 $ 16,449
Financial year loss ratio ................ 76.8% 70.4% 105.4%
Accident year loss ratio ................. 93.6% 76.1% 65.7%
AUTOMOBILE LIABILITY
Net premiums earned ...................... $ 15,027 $ 17,517 $ 13,386
Financial year loss ratio ................ 78.2% 78.1% 70.0%
Accident year loss ratio ................. 82.6% 72.6% 66.1%
AUTOMOBILE PHYSICAL DAMAGE
Net premiums earned ...................... $ 7,039 $ 11,434 $ 12,174
Financial year loss ratio ................ 104.0% 85.5% 52.0%
Accident year loss ratio ................. 103.2% 91.3% 47.1%
PROPERTY
Net premiums earned ...................... $ 2,972 $ 3,377 $ 4,806
Financial year loss ratio ................ 202.7% 179.5% 92.8%
Accident year loss ratio ................. 210.3% 187.9% 72.9%
SURETY
Net premiums earned ...................... $ 8,061 $ 6,760 $ 4,125
Financial year loss ratio ................ 5.7% 33.4% 56.7%
Accident year loss ratio ................. 13.7% 13.1% 46.5%
INLAND MARINE
Net premiums earned ...................... $ 775 $ 1,088 $ 1,256
Financial year loss ratio ................ 138.1% 141.9% 143.0%
Accident year loss ratio ................. 137.5% 179.2% 103.5%
ACCIDENT AND HEALTH
Net premiums earned ...................... $ 8,195 $ 3,190 $ 319
Financial year loss ratio ................ 103.9% 160.9% 281.2%
Accident year loss ratio ................. 107.8% 118.0% -%
TOTAL
Net premiums earned ...................... $ 87,098 $ 85,519 $ 69,985
Financial year loss ratio ................ 78.8% 76.0% 75.1%
Accident year loss ratio ................. 85.6% 72.0% 57.0%
See "Premiums Earned" and "Losses and Loss Adjustment Expenses".
PAGE 22
PREMIUMS EARNED
The following tables set forth premiums earned on a gross basis (before
reductions for premiums ceded to reinsurers) and on a net basis (after such
reductions) for each insurance program as well as each line of insurance as of
December 31 for each year presented:
INSURANCE PROGRAMS GROSS PREMIUMS EARNED NET PREMIUMS EARNED
- ---------------------------------- ----------------------------- -----------------------------
1999 2000 2001 1999 2000 2001
--------- --------- --------- --------- --------- ---------
(In thousands)
Standard property and casualty..... $ 99,512 $139,051 $128,554 $ 56,673 $ 62,823 $ 53,130
Political subdivisions ............ 29,994 34,353 34,178 14,320 12,826 12,534
Surety bonds ...................... 13,660 13,691 8,796 7,835 6,467 4,125
Group accident and health ......... 9,098 3,394 342 8,195 3,190 319
Other ............................. 183 278 (271) 75 213 (123)
--------- --------- --------- --------- --------- ---------
TOTAL ............................. $152,447 $190,767 $171,599 $ 87,098 $ 85,519 $ 69,985
========= ========= ========= ========= ========= =========
LINES OF INSURANCE GROSS PREMIUMS EARNED NET PREMIUMS EARNED
- ---------------------------------- ----------------------------- -----------------------------
1999 2000 2001 1999 2000 2001
--------- --------- --------- --------- --------- ---------
(In thousands)
Other liability .................. $ 26,260 $ 37,543 $ 36,166 $ 15,785 $ 20,992 $ 17,470
Workers compensation.............. 51,106 61,888 57,585 29,244 21,161 16,449
Automobile liability.............. 22,701 31,427 27,237 15,027 17,517 13,386
Automobile physical damage........ 8,081 13,224 13,516 7,039 11,434 12,174
Property.......................... 17,196 22,682 22,377 2,972 3,377 4,806
Surety............................ 13,886 13,983 8,796 8,061 6,760 4,125
Inland marine..................... 4,119 6,626 5,580 775 1,088 1,256
Accident and health............... 9,098 3,394 342 8,195 3,190 319
--------- --------- --------- --------- --------- ---------
TOTAL............................. $152,447 $190,767 $171,599 $ 87,098 $ 85,519 $ 69,985
========= ========= ========= ========= ========= =========
Gross premiums earned increased 21% and 25% in 1999 and 2000,
respectively. The increases in 1999 and 2000 were primarily attributable to
increases in premium production in Texas and Oklahoma, and to increases in
premium rates during 2000. Gross premiums earned decreased 10% in 2001
despite increases in premium rates as NAICO focused on improving underwriting
profitability in its core programs and discontinued certain classes of
business. Net premiums earned increased 66% in 1999, decreased 2% in 2000 and
decreased 18% in 2001. The rescission of two reinsurance treaties increased
net premiums earned in 1999 by $19.6 million. During 2000, NAICO purchased
additional reinsurance for its workers compensation and casualty lines of
business which reduced NAICO's net retention for these lines of business and
also reduced net premiums earned. Effective October 1, 2000, NAICO purchased
quota share reinsurance which reduced NAICO's net retention for its casualty
and workers compensation lines of business. The purchase of the quota share
reinsurance reduced net premiums earned by $3.2 million and $11.3 million in
2000 and 2001, respectively.
Gross premiums earned in the standard property and casualty program
increased 30% and 40% in 1999 and 2000, respectively. The increases in 1999
and 2000 were primarily attributable to increases in premium production in
Texas and Oklahoma, and to increases in premium rates during 2000. Gross
premiums earned decreased 8% in 2001 due primarily to discontinuing certain
accounts and classes of business where rates were not believed to be
adequate. Increases in premium rates partially offset the decrease in premium
production. Net premiums earned increased 94% in 1999, increased 11% in 2000
and decreased 15% in 2001. The rescission of the reinsurance treaties
increased net premiums earned in 1999 by $17.3 million in this program. The
purchase of the quota share reinsurance reduced net premiums earned by $2.7
million and $9.5 million in this program in 2000 and 2001, respectively.
Gross premiums earned in the political subdivisions program increased 20%
and 15% in 1999 and 2000, respectively, and decreased 1% in 2001. The
increases in 1999 and 2000 were due primarily to expansion of the school
districts portion of the program in Texas and Missouri during 1998 and 1999,
and to rate increases in the school districts portion of the program during
2000. Net premiums earned increased 37% in 1999, decreased 10% in 2000 and
decreased 2% in 2001. The rescission of the reinsurance treaties increased
net premiums earned in 1999 by $2.3 million in this program. The purchase of
the quota share reinsurance reduced net premiums earned by $504,000 and $1.8
million in this program in 2000 and 2001, respectively.
PAGE 23
Gross premiums earned in the surety bond program increased 15% in 1999,
increased less than 1% in 2000 and decreased 36% in 2001. The decrease in
2001 was due primarily to decreased written premium production in California,
Louisiana and Wisconsin. Net premiums earned in the surety bond program
increased 5% in 1999, decreased 17% in 2000 and decreased 36% in 2001. NAICO
experienced a significant increase in the cost of reinsurance for its
construction surety bond program during 2000 and 2001 due to an increase in
losses in the program.
Gross premiums earned in the group accident and health program increased
50% in 1999, decreased 63% in 2000 and decreased 90% in 2001. Net premiums
earned increased 78% in 1999, decreased 61% in 2000 and decreased 90% in 2001.
NAICO discontinued this program during 2000 due to poor underwriting results.
Other programs in the preceding table include premiums from the runoff of
various programs which are no longer offered by NAICO and from NAICO's
participation in various mandatory pools covering workers compensation for
insureds that were unable to purchase this coverage from an insurance company
on a voluntary basis, and direct assignments to write workers compensation for
such insureds in certain states in lieu of participating in related pools.
NET INTEREST INCOME AND NET REALIZED INVESTMENT GAINS
At December 31, 2001, Chandler USA's investment portfolio consisted
primarily of fixed income U.S. Government and high-quality corporate bonds,
with approximately 6% invested in cash and money market instruments. Income
generated from this portfolio is largely dependent upon prevailing levels of
interest rates. Chandler USA's portfolio contains no non-investment grade
bonds or real estate investments. Chandler USA also receives interest income
from Chandler Barbados on intercompany loans.
Net interest income, excluding interest income from Chandler Barbados,
decreased 19% in 1999, increased 9% in 2000 and decreased 15% in 2001. The
decrease in net interest income in 1999 was due primarily to a reduction in
invested assets due to the purchase of additional reinsurance. The increase
in 2000 was due primarily to an increase in average invested assets and an
increase in the average net yield on the portfolio. The decrease in 2001 was
due primarily to lower interest rates in 2001 and a reduction in invested
assets due primarily to the decrease in written premiums. During 2001,
Chandler USA's interest income from Chandler Barbados was $371,000 due
primarily to an intercompany loan to provide financing for the going private
transaction. Chandler USA did not have any interest income from Chandler
Barbados during 1999 or 2000. See Liquidity and Capital Resources.
Net realized investment gains were $57,000, $144,000 and $2,654,000 in
1999, 2000 and 2001, respectively. The net realized investment gains in 2001
resulted primarily from sales of fixed maturity investments available for
sale to provide cash for operating activities due to the decrease in written
premiums.
The average net yield on the portfolio, including net realized investment
gains, was 4.3%, 4.5% and 7.7% in 1999, 2000 and 2001, respectively. The
average net yield on the portfolio, excluding net realized investment gains,
was 4.2%, 4.4% and 4.5% for 1999, 2000 and 2001, respectively. Chandler USA
excludes interest income from related parties when calculating its average net
yield on the portfolio. Chandler USA's average net yield has been reduced by
investment expenses to subsidize a premium finance program for certain
insureds of NAICO. While such expenses reduce Chandler USA's average net
yield, the premium finance program enhances cash flow by providing cash which
is available for investment earlier than conventional deferred payment plans.
Based on information provided by the premium finance company, the outstanding
balance of premiums financed at December 31, 2001 was approximately $13
million. The average yield on the portfolio before deducting investment
expenses was 5.6%, 6.1% and 6.0% in 1999, 2000 and 2001, respectively,
excluding capital gains.
FEE FOR RESCINDED REINSURANCE TREATIES
During the fourth quarter of 1999, NAICO and Reliance rescinded two
reinsurance treaties which covered a portion of its workers compensation
business and which had been in effect since January 1, 1999. The reinsurer
returned the reinsurance premiums that had been paid by NAICO during 1999,
less losses and ceding commissions that had been paid by the reinsurer, and
NAICO reassumed certain losses as a result of the rescission. The reinsurer
also paid NAICO a fee of $10.0 million as additional compensation for
rescinding the treaties.
COMMISSIONS, FEES AND OTHER INCOME
Commissions, fees and other income decreased 15% and 5% in 1999 and
2000, respectively, and increased 27% in 2001. The increase in 2001 was due
to increased commission income in L&W due to increased premium production and
increased commissions from higher premium rates. The majority of Chandler
USA's income from commissions, fees and other income is from L&W. A large
portion of the brokerage commissions and fees for L&W is incurred by NAICO
and thus eliminated in the consolidation of Chandler USA's subsidiaries.
PAGE 24
LOSSES AND LOSS ADJUSTMENT EXPENSES
Chandler USA estimates losses and loss adjustment expenses based on
historical experience and payment and reporting patterns for the type of risk
involved. These estimates are based on data available at the time of the
estimate and are periodically reviewed by independent professional actuaries.
See "Business - Reserves."
The percentage of losses and loss adjustment expenses to net premiums
earned ("loss ratio") was 78.8%, 76.0% and 75.1% in 1999, 2000 and 2001,
respectively. The rescission of the reinsurance treaties increased losses and
loss adjustment expenses in 1999 by $17.0 million. Excluding the effect of
the reinsurance rescission, the loss ratio was 76.6% in 1999. Weather-related
losses (net of applicable reinsurance) from wind and hail were $4.3 million,
$2.9 million and $2.0 million in 1999, 2000 and 2001, respectively, and
increased the respective loss ratios by 6.4, 3.4 and 2.9 percentage points
(excluding the effect of the reinsurance rescission in 1999). The 1999 year
included $1.8 million in weather-related losses which resulted from the
tornadoes, strong winds and hail that caused significant damage in Oklahoma on
May 3, 1999. The decrease in weather-related losses in 2000 was largely
offset by adverse loss experience in the group accident and health program and
higher than normal losses in NAICO's surety bond program. During 2001, NAICO
experienced a further decline in weather-related losses, and increases in
premium rates resulted in improved loss ratios for its standard property and
casualty and political subdivisions programs for the 2001 accident year.
However, these improvements were offset by adverse loss development
experienced during 2001 related to prior accident years totaling $12.7
million. This adverse loss development was due primarily to increased loss
severity in the standard property and casualty and political subdivisions
programs. A substantial part of this loss development was for workers
compensation losses in the 1999 accident year. NAICO's net retention for
workers compensation losses increased substantially in 1999 due to the
rescission of certain reinsurance treaties covering this line of business.
Also contributing to the adverse loss development were provisions for
potentially uncollectible reinsurance and deductibles of approximately $1.2
million during 2001, an increase in losses in the surety bond program and
approximately $878,000 in losses for the runoff of the discontinued group
accident and health program.
At this time, NAICO has not received any claims related to the September
11, 2001 terrorist attacks on the World Trade Center and does not believe that
it has any significant exposure to these and related losses. While several of
NAICO's reinsurers did experience significant losses related to these attacks,
it currently does not appear that these losses will impair the reinsurers'
ability to pay claims.
POLICY ACQUISITION COSTS
Policy acquisition costs consist of costs associated with the acquisition
of new and renewal business and generally include direct costs such as premium
taxes, commissions to agents and ceding companies and premium-related
assessments and indirect costs such as salaries and expenses of personnel who
perform and support underwriting activities. NAICO also receives ceding
commissions from reinsurers who assume premiums from NAICO under certain
reinsurance contracts and the ceding commissions are accounted for as a
reduction of policy acquisition costs. Direct policy acquisition costs and
ceding commissions are deferred and amortized over the terms of the policies.
When the sum of the anticipated losses, loss adjustment expenses and
unamortized policy acquisition costs exceeds the related unearned premiums,
including anticipated investment income, a provision for the indicated
deficiency is recorded.
The following table sets forth Chandler USA's policy acquisition costs
for each of the three years ended December 31, 1999, 2000 and 2001:
YEAR ENDED DECEMBER 31,
-----------------------------------
1999 2000 2001
---------- ---------- -----------
(In thousands)
Commissions expense......................... $ 20,532 $ 22,780 $ 18,180
Other premium related assessments .......... 1,214 989 463
Premium taxes .............................. 3,179 4,487 4,276
Excise taxes ............................... 236 351 234
Dividends to policyholders ................. 324 190 143
Other expense .............................. 205 176 295
---------- ---------- -----------
Total direct expenses ...................... 25,690 28,973 23,591
Indirect underwriting expenses ............. 16,354 17,483 14,240
Commissions received from reinsurers ....... (17,670) (32,447) (27,325)
Adjustment for deferred acquisition costs .. (3,214) 3,146 443
---------- ---------- -----------
Net policy acquisition costs ............... $ 21,160 $ 17,155 $ 10,949
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PAGE 25
Total gross direct and indirect expenses as a percentage of direct
written and assumed premiums were 24.8%, 23.6% and 23.8% in 1999, 2000 and
2001, respectively. For these periods, commission expense as a percentage of
gross written and assumed premiums was 12.1%, 11.6% and 11.4%. Indirect
underwriting expenses were 9.6%, 8.9% and 9.0% of total direct written and
assumed premiums in 1999, 2000 and 2001, respectively. Indirect expenses
include general overhead and administrative costs associated with the
acquisition of new and renewal business, some of which is relatively fixed in
nature, thus, the percentage of such expenses to direct written and assumed
premiums will vary depending on Chandler USA's overall premium volume.
Premium taxes increased $1.3 million in 2000 due to the increase in written
premiums and to a refund of $392,000 which was received in 1999 for premium
taxes paid in a prior year. Expenses associated with guaranty fund
assessments, net of applicable premium tax credits, were approximately
$63,000, $252,000 and $489,000 in 1999, 2000 and 2001, respectively, and are
included in premium taxes. NAICO may receive additional guaranty fund
assessments in the future related to Reliance or other insolvent insurance
companies. At this time, NAICO is unable to estimate the amount of