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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, 2002
COMMISSION FILE NUMBER: 1-15135
CHANDLER (U.S.A.), INC.
(Exact name of registrant as specified in its charter)
OKLAHOMA 73-1325906
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1010 MANVEL AVENUE, CHANDLER, OKLAHOMA 74834
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (405) 258-0804
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
----------------------------------- -----------------------------------------
$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
---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). YES NO X
--- ---
Aggregate market value of the voting stock held by non-affiliates of the
registrant on June 30, 2002 and February 28, 2003: None.
The number of common shares, $1.00 par value, of the registrant outstanding on
February 28, 2003 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, including the ability to implement price increases; (iv)
claims frequency; (v) claims severity; (vi) catastrophic events of
unanticipated frequency or severity; (vii) the number of new and renewal
policy applications submitted to National American Insurance Company ("NAICO")
by its agents; (viii) the ability of NAICO to obtain adequate reinsurance in
amounts and at rates that will not adversely affect its competitive position;
(ix) the ability of NAICO to maintain favorable insurance company ratings; and
(x) various other factors.
ITEM 1. BUSINESS
GENERAL
Chandler USA is an insurance holding company that provides administrative
services to its wholly owned subsidiaries NAICO and Chandler Insurance
Managers, Inc. ("CIMI"). Chandler USA is an Oklahoma corporation which is
wholly owned by Chandler Insurance (Barbados), Ltd. ("Chandler Barbados"),
which, in turn, is wholly owned by Chandler Insurance Company, Ltd. ("Chandler
Insurance"), a privately owned Cayman Islands company. Chandler USA is
headquartered in Chandler, Oklahoma, in facilities also occupied by NAICO and
CIMI.
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
175 at December 31, 2002, that market NAICO's insurance products. Independent
agents originate substantially all of NAICO's business. NAICO is licensed to
write property and casualty coverage in 45 states and the District of Columbia
and is authorized by the United States Department of the Treasury to write
surety bonds for contractors on federal projects. NAICO is currently rated as
B++ (Very Good) by A.M. Best Company, an insurance rating agency. This rating
is an independent opinion of a company's financial strength, operating
performance and ability to meet its obligations to policyholders.
On December 20, 2002, Chandler USA completed the sale of its wholly owned
subsidiary, LaGere & Walkingstick Insurance Agency, Inc. ("L&W"), to Brown &
Brown, Inc. for $3,247,000 in cash and a $361,000 note receivable. Chandler
USA recorded an after-tax gain of $671,000 on the sale based on the minimum
purchase price for the transaction. This amount may be increased over the
next three years depending on certain adjustments as defined in the terms of
the transaction. The transaction was effective December 1, 2002. L&W is
expected to continue to be a significant producer of business for NAICO.
Retail business produced by L&W and placed with NAICO constituted approximately
8% of NAICO's direct premiums written and assumed in 2002. Chandler USA will
maintain certain wholesale operations related to NAICO's school districts and
trucking programs through CIMI, an underwriting manager that was established
in December 2002. L&W previously functioned as Chandler USA's agency segment
and is presented as discontinued operations. See Note 4 to Consolidated
Financial Statements for more information on the sale of L&W.
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.
PAGE 2
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
primarily for school districts in Oklahoma. As of December 31, 2002, NAICO
insured 444 school districts primarily in Oklahoma. The coverages offered
include workers compensation, automobile liability, automobile physical damage,
general liability, property and school board legal liability. NAICO has also
written property and casualty insurance for municipalities, primarily in
Oklahoma. During 2002, NAICO significantly reduced its premium writings in
this portion of the program.
SURETY BOND PROGRAM
NAICO writes surety bonds, commonly referred to as contract performance
bonds, to secure the performance of contractors and suppliers on construction
projects. Individual bonds generally do not exceed $3.5 million, and an
individual contractor generally does not have "work in progress" for both
bonded and unbonded jobs in excess of $7 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. NAICO has reduced
the underwriting authority for the bail bond program for 2003, and expects to
discontinue the bail bond program by the end of 2003.
The following table shows gross premiums earned and net premiums earned
by insurance program for the years 2000, 2001 and 2002. 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 2000 2001 2002 2000 2001 2002
- ------------------------------------- -------- -------- -------- -------- -------- --------
(In thousands)
Standard property and casualty ...... $139,051 $128,554 $106,051 $ 62,823 $ 53,130 $ 49,570
Political subdivisions .............. 34,353 34,178 35,159 12,826 12,534 13,829
Surety bonds ........................ 13,691 8,796 5,104 6,467 4,125 3,310
Other (1) ........................... 3,672 71 249 3,403 196 248
-------- -------- -------- -------- -------- --------
TOTAL ............................... $190,767 $171,599 $146,563 $ 85,519 $ 69,985 $ 66,957
======== ======== ======== ======== ======== ========
- ------------------------------
(1) This category is comprised primarily of the run-off of discontinued programs and NAICO's
participation in various mandatory workers compensation pools and assigned risks.
PAGE 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,
--------------------------------------------
1998 1999 2000 2001 2002
-------- -------- -------- -------- --------
Automobile liability .................. 22% 17% 20% 19% 25%
Other liability ....................... 22% 19% 25% 25% 25%
Workers compensation .................. 19% 34% 25% 24% 22%
Automobile physical damage ............ 9% 8% 13% 17% 14%
Property .............................. 4% 3% 4% 7% 8%
Surety ................................ 14% 9% 8% 6% 5%
Inland marine ......................... 1% 1% 1% 2% 1%
Accident and health ................... 9% 9% 4% -% -%
-------- -------- -------- -------- --------
Total ............................ 100% 100% 100% 100% 100%
======== ======== ======== ======== ========
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 2000, 2001 and 2002,
the gross written premiums in this program were $2.5 million, $2.3 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.
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, 2003 reinsurance programs. At the present
time, NAICO expects to renew the reinsurance programs that renew on April 1 or
July 1, 2003, as applicable.
PAGE 4
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 2000 workers compensation reinsurance program, NAICO's net
retention was 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. Effective July 1, 2002, NAICO's
net retention increased to 50% of the first $250,000 of loss per occurrence.
Under the 2000 casualty reinsurance program, NAICO retained 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.
Effective July 1, 2002, NAICO's net retention increased to 80% of the first
$250,000 of loss per occurrence.
Under the construction surety bond reinsurance program, NAICO's net
retention was 50% of the first $250,000 plus 5% of $6,000,000 excess of
$4,000,000 per principal (e.g., contractor) during 2000. Effective April 1,
2001, NAICO's net retention increased to 50% of the first $350,000 plus 5% of
$6,000,000 excess of $4,000,000 per principal. Effective April 1, 2002,
NAICO's net retention increased to 50% of the first $1,000,000 plus 10% of
$4,000,000 excess of $1,000,000 per principal.
Under the 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 $1,500,000 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 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.
On November 26, 2002, President Bush signed the Terrorism Risk Insurance
Act of 2002 (the "Act"), establishing a program for commercial property and
casualty losses, including workers compensation, resulting from foreign acts
of terrorism. The Act requires commercial insurers to offer terrorism coverage
immediately on its commercial property and casualty lines of business. Each
insurance company will be responsible for a deductible based on a percentage of
direct earned premiums from the previous calendar year, which rises from 1% for
losses occurring in 2002, to 7% in 2003, 10% in 2004 and 15% in 2005. The
Federal Government will pay 90% of covered terrorism losses that exceed company
deductibles. The Federal Government will be required to recoup the portion of
any federal compensation paid to the extent that industry retentions are less
than $10 billion for events in 2002 and 2003, $12.5 billion for 2004 and $15
billion for 2005. The recoupment will be accomplished through a surcharge on
all policyholders, not to exceed 3% of premiums in a given year. The Act is
scheduled to expire on December 31, 2005.
Effective January 1, 2003, NAICO purchased quota share reinsurance for its
deductible under the Act limiting NAICO's retention to 10% of such deductible
subject to a reinsurance limit of $9,450,000 for each loss occurrence. The
reinsurance coverage is also limited to $9,450,000 for all occurrences for any
year. NAICO also purchased excess of loss reinsurance covering acts of
terrorism that provides coverage of $20 million excess of $10 million of loss
per occurrence based on NAICO's net retention.
PAGE 5
The following table sets forth certain information related to NAICO's
five largest reinsurers determined on the basis of net reinsurance
recoverables as of December 31, 2002.
CEDED REINSURANCE
NET PREMIUMS FOR A.M. BEST
REINSURANCE THE YEAR ENDED COMPANY
NAME OF REINSURER RECOVERABLE (1) DECEMBER 31, 2002 RATING
- ----------------------------------------------------------- --------------- ----------------- ---------
(Dollars in thousands)
Swiss Reinsurance America Corporation ..................... $ 34,661 $ 10,264 A++
Chandler Barbados ......................................... 17,798 24,115 -(2)
GE Reinsurance Corporation ................................ 11,090 1,958 A+
Employers Reinsurance Corporation ......................... 6,869 10,151 A+
Red River Reinsurance, Ltd. ............................... 5,798 5,674 -(3)
--------------- -----------------
Top five reinsurers .................................. $ 76,216 $ 52,162
=============== =================
All reinsurers ....................................... $ 98,575 $ 72,495
=============== =================
Percentage of total represented by top five reinsurers .... 77% 72%
- -------------------------------------------------------------
(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, 2002.
(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, 2002, Chandler Barbados had cash and investments with a fair value of $18.7 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, 2002,
Red River's reinsurance recoverables were collateralized by cash and investments with a
fair value of $5.9 million deposited in a trust account for the benefit of NAICO and by
premiums payable to Red River of approximately $766,000.
Transamerica Occidental Life Insurance Company ("Transamerica") reinsured
NAICO for certain workers compensation risks during 1989, 1990 and 1991.
Beginning in 1996, Transamerica refused to pay NAICO for balances that it owed
under the reinsurance treaties. Transamerica owed NAICO approximately $1.5
million for reinsurance recoverables on paid losses and loss adjustment
expenses as of December 31, 2002. NAICO is currently engaged in arbitration
in order to enforce the terms of the reinsurance treaties.
Reliance Insurance Company ("Reliance") reinsured NAICO for certain
workers compensation risks during 1998. At December 31, 2002, NAICO had
reinsurance recoverables from Reliance for paid and unpaid losses of
approximately $2.8 million. During October 2001, the Commonwealth of
Pennsylvania placed Reliance in liquidation. At this time, NAICO is unable to
determine the amount of its reinsurance recoverables from Reliance that will
ultimately be collected and has fully reserved the carrying value of such
amounts as of December 31, 2002.
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 unaffiliated
reinsurers in 2000. During 2001 and 2002, NAICO incurred charges of $454,000
and $1.7 million, respectively, in adjustments to ceded losses and loss
adjustment expenses for amounts deemed uncollectible.
PAGE 6
LOSS AND UNDERWRITING EXPENSE RATIOS
The combined loss and underwriting expense ratio ("Combined Ratio") is
the traditional measure of underwriting experience for property and casualty
insurance companies. It is the sum of the ratios of (i) incurred losses and
loss adjustment expenses to net premiums earned ("loss ratio") and (ii)
underwriting expenses to net premiums written and assumed ("underwriting
expense ratio").
The following table shows the underwriting experience of Chandler USA for
the periods indicated by line of insurance written. Adjustments to reserves
made in subsequent periods are reflected in the year of adjustment. In the
following table, incurred losses include paid losses and loss adjustment
expenses, net changes in case reserves for losses and loss adjustment expenses
and net changes in reserves for incurred but not reported losses and loss
adjustment expenses. See also "Reserves" and "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS."
YEAR ENDED DECEMBER 31,
--------------------------------------------
1998 1999 2000 2001 2002
-------- -------- -------- -------- --------
(Dollars in thousands)
Automobile liability:
Net premiums earned ................ $ 11,419 $ 15,027 $ 17,517 $ 13,386 $ 16,526
Loss ratio ......................... 75% 78% 78% 70% 81%
Other liability:
Net premiums earned ................ $ 11,357 $ 15,785 $ 20,992 $ 17,470 $ 16,458
Loss ratio ......................... 66% 70% 56% 57% 80%
Workers compensation (1):
Net premiums earned ................ $ 9,937 $ 29,244 $ 21,161 $ 16,449 $ 14,808
Loss ratio ......................... 66% 77% 70% 105% 99%
Automobile physical damage:
Net premiums earned ................ $ 4,702 $ 7,039 $ 11,434 $ 12,174 $ 9,552
Loss ratio ......................... 86% 104% 85% 52% 35%
Property:
Net premiums earned ................ $ 2,332 $ 2,972 $ 3,377 $ 4,806 $ 5,543
Loss ratio ......................... 136% 203% 179% 93% 50%
Surety:
Net premiums earned ................ $ 7,619 $ 8,061 $ 6,760 $ 4,125 $ 3,310
Loss ratio ......................... 18% 6% 33% 57% 59%
Inland marine:
Net premiums earned ................ $ 448 $ 775 $ 1,088 $ 1,256 $ 760
Loss ratio ......................... 126% 138% 142% 143% 100%
Accident and health:
Net premiums earned ................ $ 4,610 $ 8,195 $ 3,190 $ 319 $ -
Loss ratio ......................... 91% 104% 161% 281% -%
Total (1):
Net premiums earned ................ $ 52,424 $ 87,098 $ 85,519 $ 69,985 $ 66,957
Loss ratio ......................... 69% 79% 76% 75% 76%
Underwriting expense ratio (2) ..... 33% 32% 30% 33% 34%
-------- -------- -------- -------- --------
Combined ratio (2) ................. 102% 111% 106% 108% 110%
======== ======== ======== ======== ========
- -----------------------------------------
(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 $5.0 million and $5.6 million at
December 31, 2001 and 2002, respectively. NAICO's statutory-based reserves
(reserves calculated in accordance with an insurer's domiciliary state
insurance regulatory authorities) do not differ from its reserves reported on
the basis of accounting principles generally accepted in the United States of
America ("GAAP"). NAICO does not discount its reserves for unpaid losses or
loss adjustment expenses.
NAICO participates in various pools covering workers compensation risks
for insureds who were unable to purchase this coverage from an insurance
company on a voluntary basis. In addition, NAICO receives direct assignments
to write workers compensation for such insureds in lieu of participating in
the pools. The consolidated financial statements reflect the reserves for
unpaid losses and loss adjustment expenses and net premiums earned from its
participation in the pools and from these direct assignments.
There may be significant reporting lags between the occurrence of the
insured loss and the time it is actually reported to the insurer. The
inherent uncertainties in estimating insurance reserves are generally greater
for casualty coverages, such as workers compensation, general and automobile
liability, than for property coverages primarily due to the longer period of
time that typically elapses before a definitive determination of ultimate
loss can be made, which is also affected by changing theories of legal
liability and changing political climates.
There are significant additional uncertainties in estimating the amount
of reserves required for environmental, asbestos-related and other latent
exposure claims, including a lack of historical data, long reporting delays
and complex unresolved legal issues regarding policy coverage and the extent
and timing of any such contractual liability. Courts have reached different
and frequently inconsistent conclusions as to when the loss occurred, what
claims are covered, under what circumstances the insurer has an obligation to
defend, how policy limits are determined and how policy exclusions are applied
and interpreted.
The loss settlement period on insurance claims for property damage is
relatively short. The more severe losses for bodily injury and workers
compensation claims have a much longer loss settlement period and may be paid
out over several years. It is often necessary to adjust estimates of liability
on a loss either upward or downward from the time a claim arises to the time of
payment. Workers compensation indemnity benefit reserves are determined based
on statutory benefits described by state law and are estimated based on the
same factors generally discussed above which may include, where state law
permits, inflation adjustments for rising benefits over time. Generally, the
more costly automobile liability claims involve one or more severe bodily
injuries or deaths. The ultimate cost of these types of claims is dependent on
various factors including the relative liability of the parties involved, the
number and severity of injuries and the legal jurisdiction where the incident
occurred.
PAGE 8
The following table sets forth a reconciliation of the beginning and
ending reserves for losses and loss adjustment expenses which are net of
reinsurance deductions for the years indicated.
YEAR ENDED DECEMBER 31,
-------------------------------------------------
1998 1999 2000 2001 2002
--------- --------- --------- --------- ---------
(In thousands)
Net balance before provision for uncollectible
reinsurance at beginning of year ............ $ 53,345 $ 39,570 $ 51,123 $ 46,588 $ 32,743
--------- --------- --------- --------- ---------
Net losses and loss adjustment expenses
incurred related to:
Current year .............................. 34,313 65,139 60,020 39,881 34,928
Prior years ............................... 1,737 3,520 4,979 12,669 15,784
--------- --------- --------- --------- ---------
Total ................................... 36,050 68,659 64,999 52,550 50,712
--------- --------- --------- --------- ---------
Net paid losses and loss adjustment expenses
related to:
Current year .............................. (19,495) (33,210) (33,525) (22,596) (13,246)
Prior years ............................... (30,330) (23,896) (36,009) (43,799) (37,050)
--------- --------- --------- --------- ---------
Total .................................. (49,825) (57,106) (69,534) (66,395) (50,296)
--------- --------- --------- --------- ---------
Net balance before provision for uncollectible
reinsurance at end of year .................. 39,570 51,123 46,588 32,743 33,159
Adjustments to reinsurance recoverables on
unpaid losses for uncollectible reinsurance.. 351 255 119 69 32
--------- --------- --------- --------- ---------
Net balance at end of year ................... $ 39,921 $ 51,378 $ 46,707 $ 32,812 $ 33,191
========= ========= ========= ========= =========
During 2001, NAICO experienced adverse loss development related to prior
accident years totaling $12.7 million due primarily to increased loss severity
in the standard property and casualty and political subdivisions programs. A
substantial part of this loss development was for workers compensation losses
in the 1999 accident year. NAICO's net retention for workers compensation
losses increased substantially in 1999 due to the rescission of certain
reinsurance treaties covering this line of business. Also contributing to the
adverse loss development were provisions for potentially uncollectible
reinsurance and deductibles of approximately $1.2 million during 2001, an
increase in losses in the surety bond program and approximately $878,000 in
losses for the runoff of the discontinued group accident and health program.
During 2002, NAICO experienced adverse loss development related to prior
accident years totaling $15.8 million primarily in the standard property and
casualty program including both liability lines and workers compensation. This
adverse development is generally the result of ongoing analysis of recent loss
development trends that reflect an increase in loss severity within the
1997-2000 accident years. The adverse loss development included approximately
$2.0 million for provisions for potentially uncollectible reinsurance and
deductibles.
The following table represents the development of net balance sheet
reserves for 1993 through 2002. The top line of the table shows the net
reserves at the balance sheet date for each of the indicated years. This
represents the estimated amounts of claims and claim expenses, net of
reinsurance deductions, arising in the current and all prior years that are
unpaid at the balance sheet date, including the net reserve for incurred but
not reported claims. The upper portion of the table shows the cumulative net
amounts paid as of successive years with respect to that reserve liability.
The estimate for unpaid losses and loss adjustment expenses changes as more
information becomes known about the frequency and severity of claims for
individual years. The next portion of the table shows the revised estimated
amount of the previously recorded net reserve based on experience as of the end
of each succeeding year. The heading "net cumulative (deficiency) redundancy"
represents the cumulative aggregate change in the estimates over all prior
years. The last portion of the table provides a reconciliation of the net
amounts to the gross amounts before any deductions for reinsurance. The gross
cumulative deficiency or redundancy results from the same factors as those
described above for the net amounts, and is also impacted by development of
large claims that exceed NAICO's net retention including umbrella and surety
per principal losses where NAICO has little or no net retention.
PAGE 9
In evaluating the information in the following table, it should be
noted that each amount includes the effects of all changes in amounts for
prior periods. For example, the amount of the deficiency recorded in 1996
for claims that occurred in 1993 will be included in the cumulative deficiency
amount for years 1993, 1994, 1995 and 1996. This table does not present
accident or policy year development data. Conditions and trends that have
affected development of the liability in the past may not necessarily occur in
the future. Accordingly, it may not be appropriate to extrapolate future
deficiencies or redundancies based on this table.
DEVELOPMENT OF RESERVES
AS OF DECEMBER 31,
---------------------------------------------------------------------------------------------------
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
--------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
(In thousands)
Net reserve for unpaid losses and
loss adjustment expenses (1) .. $ 51,648 $ 64,308 $ 58,340 $ 53,845 $ 54,035 $ 39,921 $ 51,378 $ 46,707 $ 32,812 $ 33,191
Net paid (cumulative) as of
One year later ................ 26,469 30,771 31,768 28,572 30,330 23,896 36,009 43,799 37,050
Two years later ............... 38,655 45,321 44,471 40,857 42,934 34,966 58,979 66,141
Three years later ............. 45,357 51,985 49,262 45,668 49,735 45,390 72,052
Four years later .............. 48,385 54,825 51,101 47,995 56,306 51,364
Five years later .............. 49,116 55,691 52,126 50,700 58,843
Six years later ............... 49,399 56,278 54,040 51,878
Seven years later ............. 49,681 57,826 54,574
Eight years later ............. 50,291 58,378
Nine years later .............. 50,403
Net liability re-estimated as of (1)
One year later ................ 52,058 62,757 59,644 55,713 55,772 43,441 56,357 59,376 48,596
Two years later ............... 50,135 61,924 59,605 55,599 56,362 45,373 67,469 74,325
Three years later ............. 50,492 62,737 59,155 54,528 58,176 50,146 77,842
Four years later .............. 51,022 62,636 58,247 54,834 61,096 55,303
Five years later .............. 50,981 62,195 58,445 55,615 62,750
Six years later ............... 50,954 62,295 58,567 56,347
Seven years later ............. 50,832 62,630 59,013
Eight years later ............. 50,932 63,026
Nine years later .............. 50,987
Net cumulative (deficiency)
redundancy .................... $ 661 $ 1,282 $ (673) $ (2,502) $ (8,715) $(15,382) $(26,464) $(27,618) $(15,784) $ -
Supplemental gross data:
Gross liability after
reclassification of pools -
end of year ................. $167,187 $143,437 $116,149 $ 78,114 $ 73,721 $ 80,701 $ 98,460 $100,173 $ 84,756 $ 92,606
Reclassification of pool
liabilities ................. (15,694) - - - - - - - - -
--------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
Gross liability before
reclassification of pools -
end of year (1) ............. $151,493 $143,437 $116,149 $ 78,114 $ 73,721 $ 80,701 $ 98,460 $100,173 $ 84,756 $ 92,606
Reinsurance recoverable ....... 99,845 79,129 57,809 24,269 19,686 40,780 47,082 53,466 51,944 59,415
--------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
Net liability - end of
year (1) .................... $ 51,648 $ 64,308 $ 58,340 $ 53,845 $ 54,035 $ 39,921 $ 51,378 $ 46,707 $ 32,812 $ 33,191
========= ========= ========= ========= ========= ========= ========= ========= ========= =========
Gross re-estimated
liability - latest .......... $149,556 $144,029 $121,140 $ 94,216 $ 96,020 $117,529 $159,378 $179,078 $145,968
Re-estimated recoverable -
latest ...................... 98,569 81,003 62,127 37,869 33,270 62,226 81,536 104,753 97,372
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Net re-estimated liability -
latest (1) .................. $ 50,987 $ 63,026 $ 59,013 $ 56,347 $ 62,750 $ 55,303 $ 77,842 $ 74,325 $ 48,596
========= ========= ========= ========= ========= ========= ========= ========= =========
Gross cumulative (deficiency)
redundancy .................. $ 1,937 $ (592) $ (4,991) $(16,102) $(22,299) $(36,828) $(60,918) $(78,905) $(61,212)
========= ========= ========= ========= ========= ========= ========= ========= =========
- --------------------------------------------------
(1) The December 31, 1993 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, 2002, all of the investments of NAICO were in
fixed-maturity investments (rated Aa3 or AA or better by Moody's Investors
Service, Inc. or Standard & Poor's, respectively), interest-bearing money
market accounts, a collateralized repurchase agreement and common stock
received in connection with two unaffiliated entities' conversion to for-profit
corporations. NAICO's investment portfolio is managed by the Investment
Committee of its Board of Directors. For additional information, see Notes to
Consolidated Financial Statements.
DEBENTURES
On July 16, 1999, Chandler USA completed a public offering of $24 million
principal amount of senior debentures 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. 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, 2002, Chandler USA and its subsidiaries had approximately
336 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 2001 and 2002, 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.
INSURANCE REGULATION CONCERNING CHANGE OR ACQUISITION OF CONTROL
NAICO is a domestic property and casualty insurance company organized
under the Oklahoma Insurance Code. The Oklahoma Insurance Code provides that
the acquisition or change of "control" of a domestic insurer or of any person
that controls a domestic insurer cannot be consummated without the prior
approval of the Oklahoma Department of Insurance. A person seeking to acquire
control, directly or indirectly, of a domestic insurance company or of any
person controlling a domestic insurance company must generally file with the
relevant insurance regulatory authority an application for change of control
containing certain information required by statute and published regulations
and provide a copy of such to the domestic insurer. In Oklahoma, control is
generally presumed to exist if any person, directly or indirectly, owns,
controls, holds with the power to vote or holds proxies representing 10% or
more of the voting securities of the insurance company or of any other person
or entity controlling the insurance company. The 10% presumption is not
conclusive and control may be found to exist at less than 10%.
In addition, many state insurance regulatory laws contain provisions that
require pre-notification to state agencies of a change in control of a non-
domestic insurance company admitted in that state. While such pre-notification
statutes do not authorize the state agency to disapprove the change of control,
such statutes do authorize issuance of a cease and desist order with respect
to the non-domestic insurer if certain conditions exist such as undue market
concentration.
Any future transactions that would constitute a change in control of
Chandler Insurance, 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.
PAGE 12
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, 2002, NAICO had statutory earned surplus of $11.4
million. Applying the Oklahoma statutory limits described above, the maximum
shareholder dividend NAICO may pay in 2003 without the approval of the Oklahoma
Department of Insurance is $4.4 million. NAICO paid shareholder dividends
totaling $7.0 million and $3.5 million to Chandler USA in 2001 and 2002,
respectively. The Oklahoma Department of Insurance approved the payment of the
extraordinary dividend by NAICO to Chandler USA in 2001.
In addition to the statutory limits described above, the amount of
shareholder dividends and other payments to affiliates permitted can be further
limited by contractual or regulatory restrictions or other agreements with
regulatory authorities restricting dividends and other payments, including
regulatory restrictions that are imposed as a matter of administrative policy.
If insurance regulators determine that payment of a shareholder dividend or
other payments to an affiliate (such as payments under a tax sharing agreement,
payments for employee or other services, or payments pursuant to a surplus
note) would be hazardous to such insurance company's policyholders or
creditors, the regulators may block such payments that would otherwise be
permitted without prior approval.
RISK-BASED CAPITAL
The National Association of Insurance Commissioners has adopted a
methodology for assessing the adequacy of statutory surplus of domestic
property and casualty insurers. This methodology is described in the Risk
Based Capital Model Act (the "RBC Model Act"). The RBC Model Act includes a
risk-based capital requirement that requires insurance companies to calculate
and report information under a risk-based formula which attempts to measure
statutory capital and surplus needs based on the risks in the insurance
company's mix of products and investment portfolio. The formula is designed
to allow state insurance regulators to identify potential under-capitalized
companies. Under the formula, an insurer determines its "risk-based capital"
("RBC") by taking into account certain risks related to the insurer's assets
(including risks related to its investment portfolio and ceded reinsurance)
and the insurer's liabilities (including underwriting risks related to the
nature and experience of its insurance business). The RBC rules provide for
different levels of regulatory attention depending on the ratio of a company's
total adjusted capital to its "authorized control level" of RBC. Insurers
below the specific ratios are classified within certain levels, each of which
requires specific corrective action. The levels and ratios are as follows:
Ratio of Total Adjusted Capital to
Authorized Control Level RBC
(Less than or equal to)
----------------------------------
Regulatory Event (1)
--------------------
Company Action Level (2) ....... 2.0
Regulatory Action Level (3) .... 1.5
Authorized Control Level (4) ... 1.0
Mandatory Control Level (5) .... 0.7
- ---------------------------------
(1) When an insurer's ratio exceeds 2.0, it is not subject to regulatory
attention under the RBC Model Act.
(2) "Company Action Level" requires an insurer to prepare and submit an RBC
Plan to the insurance commissioner of its state of domicile. After review,
the insurance commissioner will notify the insurer if the Plan is satisfactory.
PAGE 13
(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 6.6:1 and 5.8:1 at December 31, 2001 and 2002, respectively. Therefore,
NAICO's total adjusted capital exceeds the level that would trigger regulatory
attention pursuant to the risk-based capital requirement.
NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS-IRIS RATIOS
The National Association of Insurance Commissioners Insurance Regulatory
Information System ("IRIS") was developed by a committee of state insurance
regulators and is primarily intended to assist state insurance departments in
executing their statutory mandates to oversee the financial condition of
insurance companies operating in their respective states. IRIS identifies 12
industry ratios and specifies "usual values" for each ratio. Departure from the
"usual values," which fluctuate annually, on four or more ratios generally
leads to inquiries from individual state insurance commissioners. NAICO had
five 2002 ratios that were outside of the "usual values," four of which
resulted primarily from adverse loss development as explained below.
NAICO's "two-year overall operating ratio" for 2002 was 102% 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 2002, and to adverse loss
development recorded during 2001 and 2002 for accident years prior to 2001.
Excluding this loss development, the two-year overall operating ratio would
have been 81% for 2002.
NAICO's "investment yield" as calculated using the IRIS formula was 2.1%
during 2002 compared to a usual value of greater than 4.5% and less than 10.0%.
NAICO maintains a high-quality investment portfolio, with no non-investment
grade bonds, derivative instruments or real estate investments (other than real
estate occupied by the company), and NAICO holds only a small investment in
equity securities. NAICO's investment yield is largely dependent upon
prevailing levels of interest rates. The significant decline in interest rates
during 2001 and 2002 had a significant impact on NAICO's investment yield.
Moreover, in periods of relatively low interest rates, NAICO generally shortens
maturities and accepts lower yields to reduce market risk for future rate
increases.
Included in NAICO's investments, under statutory accounting principles, is
real estate occupied by the company of $7,708,000 at December 31, 2002. In
accordance with statutory accounting principles, NAICO records investment
income for its occupancy of the company owned real estate, and corresponding
charges for rental expense and other real estate related expenses are recorded
as a reduction of investment income. NAICO also incurred $244,000 in
investment expenses to subsidize a premium finance program for certain insureds
of NAICO during 2002. While these expenses reduced NAICO's investment yield,
the premium finance program enhances cash flow by providing cash that is
available for investment earlier than conventional deferred payment plans.
NAICO's investment yield excluding the investment income and expenses related
to the real estate and investment expenses to subsidize the premium finance
program was 4.0% during 2002.
NAICO's "one-year reserve development to policyholders' surplus" and
"two-year reserve development to policyholders' surplus" for 2002 were 30%
and 53%, 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 and 2002 related to the 1997 - 2000
accident years. This adverse loss development was due primarily to
increased loss severity in NAICO's 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 recoverables and
deductibles of $888,000 and $1,926,000 during 2001 and 2002, respectively.
Statutory accounting requires that these write-downs of receivables and
recoverables be reflected as prior year loss development. Adverse loss
development in NAICO's discontinued group accident and health program was
$900,000 and $522,000 during 2001 and 2002, respectively. This program was
discontinued during 2000 due to poor underwriting results.
PAGE 14
NAICO's "estimated current reserve deficiency to policyholders' surplus"
was 40% at December 31, 2002 compared to a usual value of less than 25%. The
adverse loss development experienced in 2001 and 2002 related to prior
accident years was primarily responsible for this ratio being outside of the
normal range. NAICO experienced significant growth from 1996 through 2000,
with gross premiums written increasing from $108 million in 1996 to $197
million in 2000. Despite the growth in written premiums, pricing competition
and expansion of coverages was prevalent throughout the industry, resulting in
a much lower premium for the exposures insured. At the same time, claim costs,
especially medical, increased at a much faster pace. Now that the results have
shown how underpriced the business was during this time, NAICO has re-priced
and re-underwritten this business. During 2001 and 2002, NAICO implemented
substantial price increases on every line of business that it writes, and
reduced the overall written premiums to $159 million and $140 million in 2001
and 2002, respectively. Further, NAICO exited some classes of business and
non-renewed accounts with severity and/or frequency exposure. Management
believes that while the insured exposure base has been significantly reduced,
the premium for that exposure has increased significantly. The calculation of
this ratio assumes that factors that led to past under reserving will cause
current under reserving without regard to changes in premium volume, premium
rates, product mix, the amount of risk retained by NAICO and current reserving
practices.
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 1,500 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
Chandler Insurance and certain of its subsidiaries and affiliates,
including Chandler USA, are involved in litigation with their director and
officer liability insurer. See Note 10 to Consolidated Financial Statements
for a discussion of this and other litigation matters.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the quarter
ended December 31, 2002.
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. 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 statement
of operations, comprehensive income, shareholder's equity and cash flows for
the years ended December 31, 2000 were audited by Deloitte & Touche LLP,
independent auditors, whose independent auditors' report expressed an
unqualified opinion and included an explanatory paragraph relating to
litigation. The consolidated balance sheets of Chandler USA and its
subsidiaries as of December 31, 2001 and 2002 and the related consolidated
statements of operations, comprehensive income, shareholder's equity and cash
flows for the years ended December 31, 2001 and 2002 have been audited by
Tullius Taylor Sartain & Sartain LLP, independent auditors, whose independent
auditors' report expresses an unqualified opinion. The selected financial data
should be read in conjunction with "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS" and the consolidated financial
statements of Chandler USA and the notes thereto appearing in Item 14(a). All
periods have been restated to reflect the results of L&W as a discontinued
operation.
PAGE 15
ITEM 6. SELECTED FINANCIAL DATA (CONTINUED)
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1998 1999 2000 2001 2002
---------- ---------- ---------- ---------- ----------
OPERATING DATA (1) (Dollars in thousands)
Revenues
Direct premiums written and assumed ............. $ 134,293 $ 169,569 $ 197,196 $ 158,964 $ 140,162
========== ========== ========== ========== ==========
Net premiums earned ............................. $ 52,424 $ 87,098 $ 85,519 $ 69,985 $ 66,957
Interest income, net ............................ 4,849 3,927 4,281 3,632 2,540
Interest income, net from related parties ....... - - - 371 380
Realized investment gains, net .................. 1,036 57 144 2,654 794
Fee for rescinded reinsurance treaties .......... - 10,000 - - -
Other income .................................... 278 164 301 101 261
---------- ---------- ---------- ---------- ----------
Total revenues .................................... 58,587 101,246 90,245 76,743 70,932
---------- ---------- ---------- ---------- ----------
Operating expenses
Losses and loss adjustment expenses ............. 36,050 68,659 64,999 52,550 50,712
Policy acquisition costs ........................ 10,673 21,195 16,882 10,869 10,239
General and administrative expenses ............. 9,474 9,126 10,557 11,549 12,473
Interest expense ................................ 885 1,494 2,255 2,240 2,234
---------- ---------- ---------- ---------- ----------
Total operating expenses .......................... 57,082 100,474 94,693 77,208 75,658
---------- ---------- ---------- ---------- ----------
Income (loss) from continuing operations before
income taxes .................................... 1,505 772 (4,448) (465) (4,726)
Federal income tax benefit (provision) ............ (278) (326) 1,347 (16) 1,680
---------- ---------- ---------- ---------- ----------
Income (loss) from continuing operations .......... 1,227 446 (3,101) (481) (3,046)
Income (loss) from discontinued operations ........ (794) (533) (894) (622) 284
Gain on sale of subsidiary ........................ - - - - 671
---------- ---------- ---------- ---------- ----------
Net income (loss) ................................. $ 433 $ (87) $ (3,995) $ (1,103) $ (2,091)
========== ========== ========== ========== ==========
Combined loss and underwriting expense ratio (2) .. 102% 111% 106% 108% 110%
BALANCE SHEET DATA
Cash and investments .............................. $ 94,947 $ 93,666 $ 104,760 $ 73,378 $ 68,276
Amounts due from related parties .................. - - - 7,880 10,582
Total assets ...................................... 223,351 256,836 273,498 234,809 229,855
Unpaid losses and loss adjustment expenses ........ 80,701 98,460 100,173 84,756 92,606
Notes payable ..................................... 9,410 - - - -
Amounts due to related parties .................... 12,219 533 717 - -
Debentures ........................................ - 24,000 24,000 24,000 24,000
Total liabilities ................................. 174,090 210,097 228,647 191,067 186,855
Shareholder's equity .............................. 49,261 46,739 44,851 43,742 43,000
- -----------------------------------------------------
(1) All periods have been restated to reflect the results of L&W as a discontinued operation. See Note 4
to Consolidated Financial Statements for more information.
(2) Interest expense is not considered an underwriting expense and has 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 16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
References to Chandler USA which follow within this Item 7 refer to
Chandler USA and its subsidiaries on a consolidated basis unless otherwise
indicated.
Chandler USA is engaged in various property and casualty insurance
operations through its wholly owned subsidiaries, NAICO and CIMI. NAICO writes
various property and casualty insurance products through three separate
marketing programs: standard property and casualty, political subdivisions and
surety bonds (including both 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. CIMI maintains certain wholesale operations related to
NAICO's school districts and trucking programs.
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.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with GAAP requires
the application of accounting policies that often involve a significant degree
of judgment. Management is required to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the periods. If management determines, as a result of its consideration of
facts and circumstances, that changes in estimates and assumptions are
appropriate, results of operations and financial position as reported in the
consolidated financial statements may change significantly. Management has
identified the following accounting policies as critical in understanding
Chandler USA's reported financial results:
RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
Insurance companies provide in their financial statements reserves for
unpaid losses and loss adjustment expenses which are estimates of the expense
of investigation and settlement of all reported and incurred but not reported
losses under their previously issued insurance policies and reinsurance
contracts. In estimating reserves, insurance companies use various
standardized methods based on historical experience and payment and reporting
patterns for the type of risk involved. The application of these methods
necessarily involves subjective determinations by the personnel of the
insurance company. Inherent in the estimates of the ultimate liability for
unpaid claims are expected trends in claim severity, claim frequency and other
factors that may vary as claims are settled. The amount of and uncertainty in
the estimates is affected by such factors as the amount of historical claims
experience relative to the development period for the type of risk, knowledge
of the actual facts and circumstances, and the amount of insurance risk
retained. The ultimate cost of insurance claims can be adversely affected by
increased costs, such as medical expenses, repair expenses, costs of providing
legal defense for policyholders, increased jury awards and court decisions and
legislation that expand insurance coverage after the insurance policy was
priced and sold. 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 17
NAICO does not ordinarily insure against environmental matters as that
term is commonly used. However, in some cases, regulatory filings made on
behalf of an insured can make NAICO directly liable to the regulatory authority
for property damage, which could include environmental pollution. In those
cases, NAICO ordinarily has recourse against the insured or the surety bond
principal for amounts paid. NAICO has insured certain trucking companies and
pest control operators who are required to provide proof of insurance which in
some cases assures payment for cleanup and restoration of damage resulting from
sudden and accidental release or discharge of contaminants or other substances
which may be classified as pollutants. NAICO also provides surety bonds for
construction contractors who use or have control of such substances and for
contractors who remove and dispose of asbestos as a part of their contractual
obligations.
NAICO also insures independent oil and gas producers who may purchase
coverage for the escape of oil, saltwater, or other substances which may be
harmful to persons or property, but may not generally be classified as
pollutants. NAICO maintains claims records which segregate this type of risk
for the purpose of evaluating environmental risk exposure. Based upon the
nature of such lines of business with NAICO's insureds, and current data
regarding the limited severity and infrequency of such matters, it appears
that potential environmental risks are not a significant portion of claim
reserves and therefore would not likely have a material adverse impact, if any,
on the financial condition of Chandler USA.
NAICO's statutory-based reserves (reserves calculated in accordance with
accounting practices prescribed or permitted by an insurer's domiciliary state
insurance regulatory authorities for purposes of financial reporting to
regulators) do not differ from its reserves reported on the basis of GAAP.
NAICO does not discount its reserves for unpaid losses and loss adjustment
expenses.
REINSURANCE RECOVERABLES
Reinsurance recoverables on unpaid losses and loss adjustment expenses are
similarly subject to changes in estimates and assumptions. Amounts recoverable
from reinsurers are estimated in a manner consistent with the claim liability
associated with the reinsured policies. In addition to factors noted above,
estimates of reinsurance recoverables may prove uncollectible if the reinsurer
is unable or unwilling to meet its responsibilities under the reinsurance
contracts. Reinsurance contracts do not relieve an insurer from its obligation
to policyholders.
OTHER
See Note 1 to Consolidated Financial Statements for information related to
other accounting and reporting policies.
ECONOMIC CONDITIONS
The impact of a recession on Chandler USA would depend on its duration and
severity. A prolonged downturn in the economy could result in decreased demand
for NAICO's insurance products and an increase in uncollectible premiums and/or
reinsurance recoverables. In addition, an economic downturn could result in an
increase in the number of insurance claims if insureds decrease expenditures
that promote safety. Much of NAICO's insurance business is concentrated in the
Southwest and Midwest areas of the United States. Approximately $127 million,
or 90%, of NAICO's direct written premiums in 2002 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 2002, the market
value of NAICO's available for sale investments increased by $2.8 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.
PAGE 18
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.
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 2001 and 2002, 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.
DISCONTINUED OPERATIONS
On December 20, 2002, Chandler USA completed the sale of its wholly owned
subsidiary L&W to Brown & Brown, Inc. for $3,247,000 in cash and a $361,000
note receivable that is due on or before December 31, 2003. Chandler USA
recorded an after-tax gain of $671,000 on the sale based on the minimum
purchase price for the transaction, after deducting Chandler USA's goodwill
related to L&W of $2,350,000, equity in L&W of $224,000 and approximately
$400,000 of expenses in connection with the sale. The gain on the sale may be
increased over the next three years depending on certain adjustments to the
purchase price as defined in the terms of the transaction, with a maximum
purchase price of $6.0 million. The transaction was effective December 1, 2002.
PAGE 19
L&W is expected to continue to be a significant producer of business for
NAICO. Retail business produced by L&W and placed with NAICO constituted
approximately 8% of NAICO's direct premiums written and assumed in 2002.
Chandler USA will maintain certain wholesale operations related to NAICO's
school districts and trucking programs through CIMI, an underwriting manager
that was established in December 2002. L&W previously functioned as Chandler
USA's agency segment and is presented as discontinued operations.
Chandler USA agreed to indemnify Brown & Brown, Inc. for any breach of a
representation, warranty or covenant made in connection with the sale for a
period of three years, and has deposited cash in the amount of $500,000 into
a trust account for the benefit of Brown & Brown, Inc. as security. Prior to
completing the sale, L&W transferred its real estate to NAICO, and transferred
substantially all of its remaining assets and liabilities, primarily premiums
receivable and premiums payable, to Chandler USA through a shareholder dividend.
ANALYSIS OF INSURANCE PROGRAM RESULTS OF OPERATIONS
The following tables summarize the net premiums earned and the financial
year (losses incurred and recognized by Chandler USA regardless of the year in
which the claim occurred) and accident year (losses incurred by Chandler USA
for a particular year regardless of the period in which Chandler USA recognizes
the costs) loss ratios (computed by dividing losses and loss adjustment
expenses by net premiums earned) in each of the years presented. The first
table is summarized by major insurance program and includes all lines of
insurance written in each program. The second table is summarized by line of
insurance written and includes all net premiums earned and net losses and loss
adjustment expenses incurred from all insurance programs for that particular
line. See "Premiums Earned" and "Losses and Loss Adjustment Expenses."
YEAR ENDED DECEMBER 31,
--------------------------------
2000 2001 2002
---------- ---------- ----------
(Dollars in thousands)
INSURANCE PROGRAMS
- ---------------------------------------------------
STANDARD PROPERTY AND CASUALTY
Net premiums earned ............................. $ 62,823 $ 53,130 $ 49,570
Financial year loss ratio ....................... 76.6% 71.0% 81.1%
Accident year loss ratio ........................ 77.4% 54.7% 58.9%
POLITICAL SUBDIVISIONS
Net premiums earned ............................. $ 12,826 $ 12,534 $ 13,829
Financial year loss ratio ....................... 80.6% 91.1% 55.9%
Accident year loss ratio ........................ 98.2% 67.3% 35.5%
SURETY BONDS
Net premiums earned ............................. $ 6,467 $ 4,125 $ 3,310
Financial year loss ratio ....................... 35.1% 56.7% 59.4%
Accident year loss ratio ........................ 14.3% 72.9% 19.2%
OTHER (1)
Net premiums earned ............................. $ 3,403 $ 196 $ 248
Financial year loss ratio ....................... 124.9% 555.4% 332.7%
Accident year loss ratio ........................ 118.4% 107.3% 79.9%
TOTAL
Net premiums earned ............................. $ 85,519 $ 69,985 $ 66,957
Financial year loss ratio ....................... 76.0% 75.1% 75.7%
Accident year loss ratio ........................ 77.4% 58.2% 52.2%
- --------------------------------------
(1) This category is comprised primarily of the run-off of discontinued programs and
NAICO's participation in various mandatory workers compensation pools and assigned
risks.
YEAR ENDED DECEMBER 31,
--------------------------------
2000 2001 2002
---------- ---------- ----------
(Dollars in thousands)
LINES OF INSURANCE
- ---------------------------------------------------
AUTOMOBILE LIABILITY
Net premiums earned ............................. $ 17,517 $ 13,386 $ 16,526
Financial year loss ratio ....................... 78.1% 70.0% 81.2%
Accident year loss ratio ........................ 75.9% 60.4% 70.6%
OTHER LIABILITY
Net premiums earned ............................. $ 20,992 $ 17,470 $ 16,458
Financial year loss ratio ....................... 55.6% 57.4% 80.2%
Accident year loss ratio ........................ 51.7% 36.3% 62.3%
WORKERS COMPENSATION
Net premiums earned ............................. $ 21,161 $ 16,449 $ 14,808
Financial year loss ratio ....................... 70.4% 105.4% 99.4%
Accident year loss ratio ........................ 85.1% 67.7% 50.7%
AUTOMOBILE PHYSICAL DAMAGE
Net premiums earned ............................. $ 11,434 $ 12,174 $ 9,552
Financial year loss ratio ....................... 85.5% 52.0% 35.3%
Accident year loss ratio ........................ 91.8% 48.6% 33.1%
PROPERTY
Net premiums earned ............................. $ 3,377 $ 4,806 $ 5,543
Financial year loss ratio ....................... 179.5% 92.8% 49.9%
Accident year loss ratio ........................ 179.0% 97.4% 25.4%
SURETY
Net premiums earned ............................. $ 6,760 $ 4,125 $ 3,310
Financial year loss ratio ....................... 33.4% 56.7% 59.4%
Accident year loss ratio ........................ 14.3% 72.9% 19.2%
INLAND MARINE
Net premiums earned ............................. $ 1,088 $ 1,256 $ 760
Financial year loss ratio ....................... 141.9% 143.0% 99.7%
Accident year loss ratio ........................ 197.4% 122.8% 40.6%
ACCIDENT AND HEALTH
Net premiums earned ............................. $ 3,190 $ 319 $ -
Financial year loss ratio ....................... 160.9% 281.2% -%
Accident year loss ratio ........................ 121.4% -% -%
TOTAL
Net premiums earned ............................. $ 85,519 $ 69,985 $ 66,957
Financial year loss ratio ....................... 76.0% 75.1% 75.7%
Accident year loss ratio ........................ 77.4% 58.2% 52.2%
PAGE 21
PREMIUMS EARNED
The following tables set forth premiums earned on a gross basis (before
reductions for premiums ceded to reinsurers) and on a net basis (after such
reductions) for each insurance program as well as each line of insurance for
each year presented:
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
-------------------------- --------------------------
INSURANCE PROGRAMS 2000 2001 2002 2000 2001 2002
- ----------------------------------------- -------- -------- -------- -------- -------- --------
(In thousands)
Standard property and casualty .......... $139,051 $128,554 $106,051 $ 62,823 $ 53,130 $ 49,570
Political subdivisions .................. 34,353 34,178 35,159 12,826 12,534 13,829
Surety bonds ............................ 13,691 8,796 5,104 6,467 4,125 3,310
Other ................................... 3,672 71 249 3,403 196 248
-------- -------- -------- -------- -------- --------
TOTAL ................................... $190,767 $171,599 $146,563 $ 85,519 $ 69,985 $ 66,957
======== ======== ======== ======== ======== ========
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
-------------------------- --------------------------
LINES OF INSURANCE 2000 2001 2002 2000 2001 2002
- ----------------------------------------- -------- -------- -------- -------- -------- --------
(In thousands)
Other liability ......................... $ 37,543 $ 36,166 $ 36,078 $ 20,992 $ 17,470 $ 16,458
Workers compensation .................... 61,888 57,585 41,958 21,161 16,449 14,808
Automobile liability .................... 31,427 27,237 27,143 17,517 13,386 16,526
Automobile physical damage .............. 13,224 13,516 10,745 11,434 12,174 9,552
Property ................................ 22,682 22,377 22,722 3,377 4,806 5,543
Surety .................................. 13,983 8,796 5,104 6,760 4,125 3,310
Inland marine ........................... 6,626 5,580 2,813 1,088 1,256 760
Accident and health ..................... 3,394 342 - 3,190 319 -
-------- -------- -------- -------- -------- --------
TOTAL ................................... $190,767 $171,599 $146,563 $ 85,519 $ 69,985 $ 66,957
======== ======== ======== ======== ======== ========
Gross premiums earned decreased 10% and 15% in 2001 and 2002,
respectively, as NAICO focused on improving underwriting profitability in its
core programs by re-underwriting and re-pricing the business and discontinuing
certain classes of business. Increases in premium rates partially offset the
decrease in premium production. Net premiums earned decreased 18% and 4% in
2001 and 2002, respectively. Effective October 1, 2000, NAICO purchased quota
share reinsurance which reduced NAICO's net retention for its casualty and
workers compensation lines of business and also reduced net premiums earned.
This quota share reinsurance expired effective January 1, 2002 and NAICO
elected not to renew it. The quota share reinsurance reduced net premiums
earned by $3.2 million, $11.3 million and $4.6 million in 2000, 2001 and 2002,
respectively.
Gross premiums earned in the standard property and casualty program
decreased 8% and 18% in 2001 and 2002, respectively. The decreases in 2001 and
2002 were 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. Gross premiums
earned in Texas decreased $4.2 million and $13.7 million in 2001 and 2002,
respectively, and gross premiums earned in Oklahoma decreased $6.9 million and
$7.2 million in 2001 and 2002, respectively. Net premiums earned decreased 15%
and 7% in 2001 and 2002, respectively. The quota share reinsurance reduced net
premiums earned by $2.7 million, $9.5 million and $3.8 million in this program
in 2000, 2001 and 2002, respectively.
Gross premiums earned in the political subdivisions program decreased 1%
in 2001 and increased 3% in 2002. Gross premiums earned in the school
districts portion of the program increased $1.2 million and $4.5 million in
2001 and 2002, respectively, due primarily to increased premium rates in
Oklahoma. This was largely offset by a decrease in gross premiums earned for
the municipalities portion of the program. Net premiums earned decreased 2%
in 2001 and increased 10% in 2002. The quota share reinsurance reduced net
premiums earned by $504,000, $1.8 million and $835,000 in this program in 2000,
2001 and 2002, respectively.
PAGE 22
Gross premiums earned in the surety bond program decreased 36% and 42% in
2001 and 2002, respectively. The decreases are primarily due to stricter
underwriting policies and a reduction in the number of appointed agents that
produce this business as NAICO focuses on improving underwriting profitability
in this program. Net premiums earned in the surety bond program decreased 36%
and 20% in 2001 and 2002, respectively.
Other programs in the preceding table include premiums from the runoff of
various programs which are no longer offered by NAICO, NAICO's participation
in various mandatory pools covering workers compensation for insureds that were
unable to purchase this coverage from an insurance company on a voluntary
basis, and direct assignments to write workers compensation for such insureds
in certain states in lieu of participating in related pools.
NET INTEREST INCOME AND NET REALIZED INVESTMENT GAINS
At December 31, 2002, Chandler USA's investment portfolio consisted
primarily of fixed income U.S. Government and high-quality corporate bonds,
with approximately 14% 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 from continuing operations, excluding interest income
from Chandler Barbados, decreased 15% and 30% in 2001 and 2002, respectively.
The decreases in 2001 and 2002 were due primarily to lower interest rates and
a reduction in invested assets. Cash and invested assets decreased from
$104.8 million at December 31, 2000 to $73.4 million and $68.3 million at
December 31, 2001 and 2002, respectively. This decrease resulted primarily
from the reduction in premiums written during 2001 and 2002, the payment of
claims for prior years and an increase in intercompany loans to Chandler
Barbados. The increase in intercompany loans during 2001 was primarily to
provide financing for a going private transaction for Chandler Insurance.
Interest income from Chandler Barbados was $371,000 and $380,000 during 2001
and 2002, respectively. Chandler USA did not have any interest income from
Chandler Barbados during 2000. See Liquidity and Capital Resources.
Net realized investment gains were $144,000, $2,654,000 and $794,000 in
2000, 2001 and 2002, respectively. The net realized investment gains in 2001
and 2002 resulted primarily from sales of fixed maturity investments available
for sale to provide cash for operating activities due to the decrease in
written premiums.
The average net yield on the portfolio, including net realized investment
gains, was 4.5%, 7.7% and 4.8% in 2000, 2001 and 2002, respectively. The
average net yield on the portfolio, excluding net realized investment gains,
was 4.3%, 4.4% and 3.7% for 2000, 2001 and 2002, 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, 2002 was approximately $11 million. The
average yield on the portfolio before deducting investment expenses was 6.1%,
5.9% and 4.4% in 2000, 2001 and 2002, respectively, excluding capital gains.
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 76.0%, 75.1% and 75.7% in 2000, 2001 and 2002,
respectively. Weather-related losses (net of applicable reinsurance) from
wind and hail were $2.9 million, $2.0 million and $1.5 million in 2000, 2001
and 2002, respectively, and increased the respective loss ratios by 3.4, 2.9
and 2.2 percentage points. During 2001, the decline in weather-related
losses and increases in premium rates resulted in improved loss ratios for the
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.
PAGE 23
During 2002, NAICO experienced adverse loss development related to prior
accident years totaling $15.8 million primarily in the standard property and
casualty program including both liability lines and workers compensation.
This adverse development is generally the result of ongoing analysis of recent
loss development trends that reflect an increase in loss severity within the
1997-2000 accident years. The adverse loss development included approximately
$2.0 million for provisions for potentially uncollectible reinsurance and
deductibles.
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
from continuing operations for each of the three years ended December 31, 2000,
2001 and 2002:
YEAR ENDED DECEMBER 31,
--------------------------------
2000 2001 2002
---------- ---------- ----------
(In thousands)
Commissions expense ........................ $ 30,851 $ 23,241 $ 20,151
Other premium related assessments .......... 989 463 1,397
Premium taxes .............................. 4,487 4,276 2,764
Excise taxes ............................... 351 234 240
Dividends to policyholders ................. 190 143 105
Other expense .............................. 176 295 567
---------- ---------- ----------
Total direct expenses ...................... 37,044 28,652 25,224
Indirect underwriting expenses ............. 9,139 9,099 8,135
Commissions received from reinsurers ....... (32,447) (27,325) (22,309)
Adjustment for deferred acquisition costs .. 3,146 443 (811)
---------- ---------- ----------
Net policy acquisition costs ............... $ 16,882 $ 10,869 $ 10,239
========== ========== ==========
Total gross direct and indirect expenses as a percentage of direct written
and assumed premiums were 23.4%, 23.7% and 23.8% in 2000, 2001 and 2002,
respectively. For these periods, commission expense as a percentage of gross
written and assumed premiums was 15.6%, 14.6% and 14.4%. Indirect underwriting
expenses were 4.6%, 5.7% and 5.8% of total direct written and assumed premiums
in 2000, 2001 and 2002, 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 decreased
$1.5 million in 2002 due to the decrease in written premiums, a decrease in
expenses associated with guaranty fund assessments and the elimination of a 2%
tax on workers compensation premiums written in Oklahoma. However, an increase
in premium related assessments in Oklahoma offset part of this savings.
Expenses associated with guaranty fund assessments, net of applicable premium
tax credits, were approximately $252,000, $489,000 and $31,000 in 2000, 2001
and 2002, respectively. 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 such assessments.
Commissions received from reinsurers included $3.4 million, $4.6 million
and $744,000 in 2000, 2001 and 2002, respectively, for the quota share
reinsurance purchased in the fourth quarter of 2000. Net policy acquisition
costs decreased $1.5 million, $4.9 million and $2.3 million in 2000, 2001 and
2002, respectively, due to the purchase of the quota share reinsurance, net of
the adjustment for deferred acquisition costs.
PAGE 24
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses from continuing operations were 5.5%,
6.7% and 8.5% of gross premiums earned in 2000, 2001 and 2002, respectively.
General and administrative expenses included $297,000 for settlement of certain
litigation, and $736,000 for a reserve for receivables related to certain
derivative claims. Amortization of Chandler USA's state insurance licenses and
goodwill was discontinued effective January 1, 2002 due to the implementation
of Statement of Financial Accounting Standard No. 142. Amortization expense
from continuing operations was $529,000 and $150,000 in 2000 and 2001,
respectively, for these items. General and administrative expenses have
historically not varied in direct proportion to Chandler USA's revenues. A
portion of such expenses is allocated to policy acquisition costs (indirect
underwriting expenses) and loss and loss adjustment expenses based on various
factors, including employee counts, salaries, occupancy and specific
identification. Because certain types of