Attached files
-------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------------------
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
---
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2010
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
--- SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from to
--------- ---------
COMMISSION FILE NUMBER: 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 Identification No.)
incorporation or organization)
1010 MANVEL AVENUE, CHANDLER, OKLAHOMA 74834
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (405) 258-0804
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 whether the registrant has submitted electronically
and posted on its corporate Web site, if any, every Interactive Data File
required to be submitted and posted pursuant to Rule 405 of Regulation S-T
during the preceding 12 months (or for such shorter period that the registrant
was required to submit and post such files). YES NO
--- ---
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, a non-accelerated filer, or a smaller reporting company.
See the definitions of "large accelerated filer," "accelerated filer" and
"smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer Accelerated filer
-- --
Non-accelerated filer X (Do not check if a smaller reporting company)
--
Smaller reporting company
--
Indicate by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act). YES NO X
--- ---
The number of common shares, $1.00 par value, of the registrant outstanding
on April 30, 2010 was 2,484, which are owned by Chandler Insurance Company, Ltd.
-------------------------------------------------------------------------------
Page i
CHANDLER (U.S.A.), INC.
INDEX
-----
PART I - FINANCIAL INFORMATION
------------------------------
ITEM 1. FINANCIAL STATEMENTS:
--------------------------------
Consolidated Balance Sheets as of March 31, 2010 (unaudited)
and December 31, 2009 ..................................................1
Consolidated Statements of Operations for the three months
ended March 31, 2010 and 2009 (unaudited) ..............................2
Consolidated Statements of Comprehensive Income for the three
months ended March 31, 2010 and 2009 (unaudited) .......................3
Consolidated Statements of Cash Flows for the three months
ended March 31, 2010 and 2009 (unaudited) ..............................4
Notes to Interim Consolidated Financial Statements (unaudited) ...........5
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
--------------------------------------------------------------------------
RESULTS OF OPERATIONS ............................................13
---------------------
ITEM 4T. CONTROLS AND PROCEDURES ............................................18
--------------------------------
PART II - OTHER INFORMATION
---------------------------
Item 1. Legal Proceedings ................................................18
Item 1A. Risk Factors .....................................................18
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds ......18
Item 3. Defaults Upon Senior Securities ..................................18
Item 4. Reserved .........................................................18
Item 5. Other Information ................................................18
Item 6. Exhibits .........................................................18
Signatures ..................................................................19
PAGE 1
CHANDLER (U.S.A.), INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands except share amounts)
March 31, December 31,
2010 2009
------------ ------------
(Unaudited)
ASSETS
Investments
Fixed maturities available for sale, at fair value
Restricted (amortized cost $33,749 and $34,923 in 2010 and 2009, respectively) ...... $ 34,262 $ 35,392
Unrestricted (amortized cost $59,688 and $66,735 in 2010 and 2009, respectively) .... 60,283 67,829
Equity securities available for sale, at fair value (cost $0 in 2010 and 2009) ....... 42 42
Short-term investments at fair value (amortized cost $95 and $380
in 2010 and 2009, respectively) ..................................................... 95 380
------------ ------------
Total investments ................................................................... 94,682 103,643
Cash and cash equivalents ($915 and $2,194 restricted in 2010 and 2009, respectively) . 17,822 7,430
Accrued investment income ............................................................. 772 1,228
Premiums receivable, less allowance for non-collection
of $352 and $291 at 2010 and 2009, respectively ...................................... 24,106 25,305
Reinsurance recoverable on paid losses ................................................ 693 316
Reinsurance recoverable on unpaid losses, less allowance for non-collection
of $283 and $298 at 2010 and 2009, respectively ...................................... 37,317 36,588
Reinsurance recoverable on unpaid losses from related parties ......................... 21,508 21,360
Prepaid reinsurance premiums .......................................................... 3,684 3,424
Prepaid reinsurance premiums to related parties ....................................... 12,392 12,276
Deferred policy acquisition costs ..................................................... 2,008 1,546
Property and equipment, net ........................................................... 7,028 7,174
Amounts due from related parties ...................................................... 12,214 12,697
State insurance licenses, net ......................................................... 3,745 3,745
Other assets .......................................................................... 10,680 10,613
------------ ------------
Total assets .......................................................................... $ 248,651 $ 247,345
============ ============
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Unpaid losses and loss adjustment expenses ........................................... $ 108,338 $ 107,341
Unearned premiums .................................................................... 45,143 44,519
Policyholder deposits ................................................................ 8,476 9,094
Accrued taxes and other payables ..................................................... 6,218 6,831
Premiums payable ..................................................................... 4,988 4,266
Premiums payable to related parties .................................................. 404 522
Debentures ........................................................................... 6,979 6,979
Junior subordinated debentures issued to affiliated trusts ........................... 20,620 20,620
------------ ------------
Total liabilities ................................................................... 201,166 200,172
------------ ------------
Shareholder's equity
Common stock, $1.00 par value, 50,000 shares authorized;
2,484 shares issued and outstanding ................................................. 2 2
Paid-in surplus ...................................................................... 60,584 60,584
Accumulated deficit .................................................................. (13,860) (14,472)
Accumulated other comprehensive income:
Unrealized gain on investments available for sale, net of deferred income taxes ..... 759 1,059
------------ ------------
Total shareholder's equity .......................................................... 47,485 47,173
------------ ------------
Total liabilities and shareholder's equity ............................................ $ 248,651 $ 247,345
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 2
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Amounts in thousands)
Three months ended March 31,
--------------------------------
2010 2009
------------- -------------
Premiums and other revenues
Direct premiums written and assumed ........................... $ 22,112 $ 24,854
Reinsurance premiums ceded .................................... (2,767) (2,542)
Reinsurance premiums ceded to related parties ................. (5,829) (6,670)
------------- -------------
Net premiums written and assumed ............................ 13,516 15,642
Increase in unearned premiums ................................. (248) (773)
------------- -------------
Net premiums earned ......................................... 13,268 14,869
Interest income, net ............................................ 733 761
Interest income, net from related parties ....................... 110 106
Realized investment gains ....................................... 928 384
Other income .................................................... 492 443
------------- -------------
Total premiums and other revenues ........................... 15,531 16,563
------------- -------------
Operating costs and expenses
Losses and loss adjustment expenses, net of amounts
ceded to related parties of $3,230 and $3,525 in
2010 and 2009, respectively ................................. 8,243 8,262
Policy acquisition costs, net of ceding commissions
received from related parties of $1,717 and $2,536 in
2010 and 2009, respectively ................................. 2,806 2,916
General and administrative expenses ........................... 2,995 3,105
Interest expense .............................................. 577 598
------------- -------------
Total operating costs and expenses .......................... 14,621 14,881
------------- -------------
Income before income taxes ...................................... 910 1,682
Federal income tax provision .................................... (298) (611)
------------- -------------
Net income .................................................... $ 612 $ 1,071
============= =============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 3
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Amounts in thousands)
Three months ended March 31,
--------------------------------
2010 2009
------------- ------------
Net income ................................................... $ 612 $ 1,071
------------- ------------
Other comprehensive loss, before income tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period .... 473 (278)
Less: Reclassification adjustment for gains included
in net income ............................................. (928) (384)
------------- ------------
Other comprehensive loss, before income tax .................. (455) (662)
Income tax benefit related to items of other
comprehensive loss .......................................... 155 225
------------- ------------
Other comprehensive loss, net of income tax .................. (300) (437)
------------- ------------
Comprehensive income ......................................... $ 312 $ 634
============= ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 4
CHANDLER (U.S.A.), INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Amounts in thousands)
Three months ended March 31,
------------------------------
2010 2009
------------ ------------
OPERATING ACTIVITIES
Net income .................................................................. $ 612 $ 1,071
Add (deduct):
Adjustments to reconcile net income to cash provided by
operating activities:
Realized investment gains, net .......................................... (928) (384)
Net losses on sale of property and equipment ............................ - 6
Amortization and depreciation expense .................................. 395 393
Provision for non-collection of premiums ................................ 61 15
Provision for non-collection of reinsurance recoverables ................ 9 112
Provision for non-collection of debenture ............................... 10 10
Net change in non-cash balances relating to operating activities:
Accrued investment income ............................................. 456 87
Premiums receivable ................................................... 1,138 2,095
Reinsurance recoverable on paid losses ................................ (401) 71
Reinsurance recoverable on unpaid losses .............................. (714) (1,978)
Reinsurance recoverable on unpaid losses from related parties ......... (148) (225)
Prepaid reinsurance premiums .......................................... (260) (206)
Prepaid reinsurance premiums to related parties ....................... (116) (336)
Deferred policy acquisition costs ..................................... (462) (89)
Other assets .......................................................... 64 396
Unpaid losses and loss adjustment expenses ............................ 997 2,578
Unearned premiums ..................................................... 624 1,316
Policyholder deposits ................................................. (618) (868)
Accrued taxes and other payables ...................................... (613) (360)
Premiums payable ...................................................... 722 (450)
Premiums payable to related parties ................................... (118) 41
------------ ------------
Cash provided by operating activities ................................... 710 3,295
------------ ------------
INVESTING ACTIVITIES
Short-term investments:
Purchases ............................................................... - (95)
Maturities .............................................................. 285 950
Unrestricted fixed maturities available for sale:
Purchases ............................................................... (24,294) (16,402)
Sales ................................................................... 25,627 6,616
Maturities .............................................................. 7,623 1,715
Cost of property and equipment purchased .................................. (42) (71)
Proceeds from sale of property and equipment .............................. - 16
------------ ------------
Cash provided by (applied to) investing activities ...................... 9,199 (7,271)
------------ ------------
FINANCING ACTIVITIES
Payments and loans from related parties ................................... 748 403
Payments and loans to related parties ..................................... (265) (565)
------------ ------------
Cash provided by (applied to) investing activities ...................... 483 (162)
------------ ------------
Increase (decrease) in cash and cash equivalents during the period .......... 10,392 (4,138)
Cash and cash equivalents at beginning of period ............................ 7,430 20,636
------------ ------------
Cash and cash equivalents at end of period .................................. $ 17,822 $ 16,498
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
PAGE 5
CHANDLER (U.S.A.), INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2010 AND 2009
(Unaudited)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Chandler
(U.S.A.), Inc. ("Chandler USA") have been prepared in accordance with
accounting principles generally accepted in the United States of America
("GAAP") for interim financial information and with the instructions to
Form 10-Q and Rule 10-01 of Regulation S-X. They do not include all
information and footnotes required by GAAP for complete financial statements.
However, except as disclosed herein, there have been no material changes in
the information included in Chandler USA's Annual Report on Form 10-K for the
year ended December 31, 2009. In the opinion of management, all adjustments
(consisting of normal recurring adjustments) considered necessary for a fair
presentation have been included. The results of operations for the three
month period ended March 31, 2010 are not necessarily indicative of the
results that may be expected for the year.
The consolidated financial statements include the accounts of Chandler USA
and all wholly owned subsidiaries that meet consolidation requirements
including National American Insurance Company ("NAICO") and Chandler
Insurance Managers, Inc. ("CIMI").
NOTE 2. SEGMENT INFORMATION
Chandler USA has two reportable operating segments: property and casualty
insurance and agency. The segments are managed separately due to the
differences in the nature of the insurance products and services sold. The
following table presents a summary of Chandler USA's operating segments for
the three month periods ended March 31, 2010 and 2009:
Property
and
casualty Intersegment Reported
insurance Agency eliminations balances
------------ ------------ ------------ ------------
(In thousands)
THREE MONTHS ENDED MARCH 31, 2010
Revenues from external customers (1) .......... $ 13,344 $ 416 $ - $ 13,760
Intersegment revenues ......................... 31 397 (428) -
Segment profit (loss) before income taxes (2).. 1,010 (100) - 910
Segment assets ................................ 246,911 8,719 (6,979) 248,651
THREE MONTHS ENDED MARCH 31, 2009
Revenues from external customers (1) .......... $ 15,014 $ 298 $ - $ 15,312
Intersegment revenues ......................... 29 803 (832) -
Segment profit before income taxes (2)......... 1,444 238 - 1,682
Segment assets ................................ 236,678 8,690 (7,830) 237,538
------------------------------------------
(1) Consists of net premiums earned and other income.
(2) Includes net realized investment gains.
Net premiums earned and losses and loss adjustment expenses within the
property and casualty insurance segment can be identified to Chandler USA
designated insurance programs and to each line of insurance. Chandler USA's
chief operating decision makers review net premiums earned and losses and
loss adjustment expenses in assessing the performance of the insurance
programs and lines of business. In addition, Chandler USA's chief operating
decision makers consider many other factors such as the lines of business
offered within each insurance program and the states in which the insurance
programs are offered. Certain discrete financial information is not readily
available by insurance programs or lines of insurance, including assets,
interest income, and investment gains or losses, allocated to each insurance
program or line of insurance. Chandler USA does not consider its insurance
programs or lines of insurance to be reportable segments, however, the
following supplemental information pertaining to net premiums earned and
losses and loss adjustment expenses is presented by insurance program and
line of insurance for the property and casualty insurance segment.
PAGE 6
THREE MONTHS ENDED MARCH 31,
--------------------------------
2010 2009
------------ ------------
(In thousands)
INSURANCE PROGRAM:
-----------------------------------------
NET PREMIUMS EARNED
Standard lines ........................ $ 12,975 $ 14,172
Political subdivisions ................ 225 644
Other ................................. 68 53
------------ ------------
TOTAL ................................. $ 13,268 $ 14,869
============ ============
LOSSES AND LOSS ADJUSTMENT EXPENSES
Standard lines ........................ $ 8,178 $ 7,702
Political subdivisions ................ (35) 409
Other ................................. 100 151
------------ ------------
TOTAL ................................. $ 8,243 $ 8,262
============ ============
THREE MONTHS ENDED MARCH 31,
--------------------------------
2010 2009
------------ ------------
(In thousands)
LINES OF INSURANCE:
-----------------------------------------
NET PREMIUMS EARNED
Workers compensation .................. $ 5,034 $ 5,130
Automobile liability .................. 4,092 4,750
Other liability ....................... 2,790 3,364
Automobile physical damage ............ 1,023 1,603
Inland marine ......................... 161 3
Property .............................. 132 3
Other ................................. 36 16
------------ ------------
TOTAL ................................. $ 13,268 $ 14,869
============ ============
LOSSES AND LOSS ADJUSTMENT EXPENSES
Workers compensation .................. $ 3,758 $ 2,408
Automobile liability .................. 2,886 3,774
Other liability ....................... 606 1,406
Automobile physical damage ............ 770 676
Inland marine ......................... 88 (64)
Property .............................. 57 (29)
Other ................................. 78 91
------------ ------------
TOTAL ................................. $ 8,243 $ 8,262
============ ============
NOTE 3. COMMITMENTS AND CONTINGENCIES
During March 2001, Chandler USA entered into a $3.8 million sale and
leaseback transaction for certain owned equipment for three years. During
March 2004 and March 2007, the lease was extended for additional three year
terms, and during March 2010, the lease was extended for an additional three
years with monthly rental installments equal to the sum of (i) $10,929 plus
(ii) interest on the unpaid lease balance at a floating interest rate of 1%
over JP Morgan Chase Bank prime, which was 4.25% at March 31, 2010. The
interest rate is subject to a minimum rate of 5.5% beginning in March 2010.
Chandler USA has the option to repurchase the equipment at the end of the
lease for approximately $1.5 million (the "Balloon Payment"), or may elect
to have the lessor sell the equipment. If the election to sell the equipment
is made, Chandler USA would retain any proceeds exceeding the Balloon Payment.
If the proceeds were less than the Balloon Payment, Chandler USA would be
required to pay the difference between the proceeds and the Balloon Payment,
not to exceed approximately $1.2 million.
PAGE 7
Chandler USA has guaranteed the obligations of Chandler Capital Trust I and
Chandler Capital Trust II (the "Capital Trusts") with respect to the trust
preferred securities they have outstanding. The Capital Trusts distribute
the interest received from Chandler USA on the junior subordinated debentures
to the holders of the trust preferred securities to fulfill their obligations
with respect to such securities. The Capital Trusts are wholly owned non-
consolidated subsidiaries of Chandler USA. Chandler USA guarantees payment
of distributions and the redemption price of the trust preferred securities
until the securities are redeemed in full. The total redemption price of the
trust preferred securities is $20.0 million.
NOTE 4. LITIGATION
In October 1999, NAICO provided surety bonds for Gulsby Engineering, Inc.
("Gulsby") in connection with contracts between Gulf Liquids New River
Project, LLC ("Gulf Liquids") and Gulsby for the construction of two gas
processing plants in Louisiana. During 2001, Gulsby became unable to pay
various vendors resulting in payments to vendors by NAICO totaling $20,182,499.
In August 2001, NAICO filed suit in federal court in Louisiana alleging that
Gulf Liquids had breached its obligations under the bonds by materially
altering certain contracts and that, as a result, NAICO was exonerated on the
bonds and should recover the amounts paid to vendors. In the fall of 2001,
Gulsby and Bay Limited, another contractor with whom Gulsby had entered into
a joint venture for the construction of other gas processing plants for Gulf
Liquids, filed lawsuits relating to those plants in Houston, Texas. Gulf
Liquids filed original actions and counterclaims. NAICO intervened in the Texas
lawsuits and, in addition, sued Williams Energy Marketing and Trading (which
later became Williams Power Company, Inc.) ("Williams") alleging fraud, breach
of contract, tortious interference with contractual relations, conspiracy and
alter ego. These claims were asserted against both Gulf Liquids and Williams.
Gulf Liquids asserted counterclaims alleging breach of contract against NAICO
and requesting contractual and statutory damages ranging from $40 million to
$80 million. The cases were consolidated for trial in the 215th Judicial
District Court in Harris County, Texas.
The trial in the Harris County cases began in late April 2006, and concluded
August 1, 2006. The jury found in favor of NAICO, Gulsby, Bay Limited and the
joint venture between Gulsby and Bay Limited ("Gulsby-Bay Plant Partners") on
all counts and fixed damages against Gulf Liquids and Williams totaling
$402,568,089. The damages determined by the jury included a total of $325
million in punitive damages. Among other findings, the jury found:
1. Williams tortiously interfered with NAICO's contractual relationship with
Gulsby and Gulf Liquids; and
2. Williams fraudulently induced NAICO to issue the surety bonds; and
3. Williams defrauded NAICO after the bonds were issued; and
4. Williams' actions were malicious; and
5. Gulf Liquids fraudulently induced NAICO to issue the surety bonds; and
6. Gulf Liquids breached its obligations to NAICO under the bonds; and
7. Williams is responsible for the claims against Gulf Liquids because Gulf
Liquids is the alter ego of Williams; and
8. There were material alterations (cardinal changes) to the contracts NAICO
bonded.
The amounts the jury found owing to NAICO included $20,182,499 in actual
damages, against both Gulf Liquids and Williams, $20 million in punitive
damages against Gulf Liquids, and $50 million in punitive damages against
Williams. The verdicts in favor of Gulsby included $20,941,436 in actual
damages against both Gulf Liquids and Williams, $25 million in punitive
damages against Gulf Liquids and $60 million in punitive damages against
Williams.
NAICO is subrogated to any recovery by Gulsby to the extent of NAICO's
losses on the bonds including loss adjustment expenses with interest from
the date the losses and loss expenses were paid.
A significant amount of NAICO's losses on the surety bonds were ceded to
various reinsurers and NAICO will be required to reimburse these reinsurers
in accordance with the agreements between NAICO and the reinsurers.
On January 28, 2008, the court entered a final judgment denying Gulf
Liquid's claims against NAICO and Gulsby, denying all of NAICO's claims
against Gulf Liquids and Williams, and entering judgment for Gulsby against
Gulf Liquids for $15,651,927 plus interest at 7.25% compounded annually
from January 28, 2008 until paid. The court also ordered Gulf Liquids to
pay Gulsby's taxable court costs, estimated at $100,000. Gulf Liquids has
appealed the judgment entered in favor of Gulsby and the denial of its claims
against NAICO and Gulsby. NAICO has appealed the trial court's denial of its
claims against Gulf Liquids and Williams and seeks entry of judgment upon the
jury verdicts for the amounts the jury found should be awarded to NAICO.
Gulsby has also appealed the trial court's final judgment, contending that
judgment should be entered in its favor against Gulf Liquids and Williams in
accordance with the jury verdicts. The recoverable amounts deducted from
Chandler USA's net liability for losses and loss adjustment expenses related
to this litigation were approximately $10.1 million at March 31, 2010 and
December 31, 2009.
PAGE 8
NOTE 5. NEW ACCOUNTING STANDARDS
Chandler USA has reviewed the recently issued accounting pronouncements and
concluded that the following new accounting standards and accounting standard
updates are applicable to Chandler USA.
In June 2009, the Financial Accounting Standards Board ("FASB") issued new
guidance on the accounting for transfers of financial assets. The new
guidance requires additional disclosures for transfers of financial assets,
including securitization transactions, and any continuing exposure to the
risks related to transferred financial assets. There is no longer a concept
of a qualifying special-purpose entity, and the requirements for derecognizing
financial assets have changed. Chandler USA has adopted this new guidance as
of January 1, 2010. The adoption of this new guidance did not have any impact
on its consolidated financial statements.
In June 2009, the FASB issued new guidance on the accounting for variable
interest entities. The new guidance requires an enterprise to perform an
analysis to determine whether the enterprise's variable interest or interests
give it a controlling financial interest in a variable interest entity; to
require ongoing reassessments of whether an enterprise is the primary
beneficiary of a variable interest entity; to eliminate the quantitative
approach previously required for determining the primary beneficiary of a
variable interest entity; to add an additional reconsideration event for
determining whether an entity is a variable interest entity when any changes
in facts and circumstances occur such that holders of the equity investment
at risk, as a group, lose the power from voting rights or similar rights of
those investments to direct the activities of the entity that most
significantly impact the entity's economic performance; and to require
enhanced disclosures that will provide users of financial statements with
more transparent information about an enterprise's involvement in a variable
interest entity. Chandler USA has adopted this new guidance as of January
1, 2010. The adoption of this new guidance did not have any impact on its
consolidated financial statements. While the trusts that hold Chandler USA's
junior subordinated debentures are variable interest entities, and Chandler
USA has 100% ownership and has guaranteed the performance of the trusts,
Chandler USA is not the primary beneficiary because its interest is not
variable. Therefore, Chandler USA does not consolidate the trusts under
this new guidance.
In January 2010, the FASB issued new guidance on improving disclosures about
fair value measurements. The new guidance does not change how fair values are
measured. Chandler USA has adopted this new guidance as of January 1, 2010.
The adoption of this new guidance did not have any impact on its consolidated
financial statements. The disclosures required by this new guidance are
included in Note 7.
NOTE 6. INVESTMENTS AND INVESTMENT INCOME
Net investment income and realized investment gains are summarized in the
following table. These amounts are net of investment expenses.
THREE MONTHS ENDED
MARCH 31,
----------------------
2010 2009
---------- ----------
(In thousands)
Interest on fixed-maturity investments ................... $ 782 $ 763
Interest on short-term investments and cash equivalents .. 6 63
Investment expenses ...................................... (55) (65)
---------- ----------
Investment income, net ................................. 733 761
---------- ----------
Realized gains, net - fixed-maturity investments ....... 928 384
---------- ----------
$ 1,661 $ 1,145
========== ==========
Investment expenses included $18,000 and $28,000 in the first quarter of
2010 and 2009, respectively, in expense to subsidize a premium finance
program for certain insureds of NAICO with an unaffiliated premium finance
company.
PAGE 9
The amortized cost of fixed maturities or cost of equity securities, gross
unrealized gains or losses, fair value and carrying value of investments are
as follows:
GROSS GROSS
UNREALIZED UNREALIZED FAIR CARRYING
MARCH 31, 2010 COST GAINS LOSSES VALUE VALUE
--------------------------------------------------- ---------- ---------- ---------- ---------- ----------
FIXED MATURITIES AVAILABLE FOR SALE: (In thousands)
U.S. Treasury securities and obligations
of U.S. government corporations
and agencies ................................... $ 43,210 $ 516 $ (19) $ 43,707 $ 43,707
Corporate obligations ............................. 19,127 398 (30) 19,495 19,495
Public utilities .................................. 1,027 45 - 1,072 1,072
Obligations of states and political subdivisions... 30,073 331 (133) 30,271 30,271
---------- ---------- ---------- ---------- ----------
$ 93,437 $ 1,290 $ (182) $ 94,545 $ 94,545
========== ========== ========== ========== ==========
EQUITY SECURITIES:
Corporate stock ................................... $ - $ 42 $ - $ 42 $ 42
========== ========== ========== ========== ==========
GROSS GROSS
UNREALIZED UNREALIZED FAIR CARRYING
DECEMBER 31, 2009 COST GAINS LOSSES VALUE VALUE
--------------------------------------------------- ---------- ---------- ---------- ---------- ----------
FIXED MATURITIES AVAILABLE FOR SALE: (In thousands)
U.S. Treasury securities and obligations
of U.S. government corporations
and agencies ................................... $ 40,395 $ 731 $ (52) $ 41,074 $ 41,074
Corporate obligations ............................. 31,989 732 (130) 32,591 32,591
Public utilities .................................. 2,052 43 - 2,095 2,095
Obligations of states and political subdivisions... 27,222 331 (92) 27,461 27,461
---------- ---------- ---------- ---------- ----------
$ 101,658 $ 1,837 $ (274) $ 103,221 $ 103,221
========== ========== ========== ========== ==========
EQUITY SECURITIES:
Corporate stock ................................... $ - $ 42 $ - $ 42 $ 42
========== ========== ========== ========== ==========
Other than investments in bonds and notes of the U.S. Government and U.S.
Government agencies and authorities, Chandler USA did not hold any fixed
maturity investments that exceeded 10% of shareholder's equity at March 31,
2010 or December 31, 2009.
The fair value of Chandler USA's investments with continuous gross unrealized
losses at March 31, 2010 is presented below:
LESS THAN 12 MONTHS 12 MONTHS OR LONGER TOTAL
----------------------- ----------------------- ------------------------
UNREALIZED UNREALIZED UNREALIZED
FAIR VALUE LOSSES FAIR VALUE LOSSES FAIR VALUE LOSSES
----------- ---------- ----------- ---------- ----------- ----------
(In thousands)
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies .......... $ 4,040 $ (19) $ - $ - $ 4,040 $ (19)
Corporate securities ................. 664 (6) 1,744 (24) 2,408 (30)
Public utilities ..................... - - - - - -
Obligations of states and political
subdivisions ....................... 12,175 (132) 574 (1) 12,749 (133)
----------- ---------- ----------- ---------- ----------- ----------
$ 16,879 $ (157) $ 2,318 $ (25) $ 19,197 $ (182)
=========== ========== =========== ========== =========== ==========
PAGE 10
The unrealized losses of Chandler USA's fixed maturity investments were
primarily caused by changes in market interest rates since the date of
purchase, current conditions in the capital markets and the impact of those
conditions on market prices. The contractual terms of those investments do
not permit the issuer to settle the securities at a price less than the
amortized cost of the investment. Chandler USA regularly reviews its
investment portfolio for factors that may indicate that a decline in fair
value of an investment is other than temporary. Based on an evaluation of
the issues, including, but not limited to, Chandler USA's intentions to
sell or ability to hold the investments; the length of time and amount of
the unrealized loss; and the credit ratings of the issuers of the investments,
Chandler USA does not consider these investments to be other-than-temporarily
impaired at March 31, 2010.
Expected maturities will differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without call or
prepayment penalties. The maturities of investments in fixed maturities at
March 31, 2010 are shown below:
AVAILABLE FOR SALE
------------------------
AMORTIZED
COST FAIR VALUE
------------ ----------
(In thousands)
Due in one year or less .......................... $ 6,784 $ 6,822
Due after one year through five years ............ 41,205 42,062
Due after five years through ten years ........... 35,676 35,838
Due after ten years .............................. 9,772 9,823
------------ ----------
$ 93,437 $ 94,545
============ ==========
Realized gains and losses from sales of investments are shown below:
THREE MONTHS ENDED
MARCH 31,
------------------
2010 2009
-------- --------
(In thousands)
FIXED MATURITIES:
Gross realized gains ............................. $ 928 $ 384
Gross realized losses ............................ - -
-------- --------
Total net realized gains ....................... $ 928 $ 384
======== ========
NAICO is required to deposit cash and securities with regulatory agencies in
which it is licensed as a condition of conducting operations in the state. In
addition, NAICO has deposited cash and securities into a trust account as
collateral for reinsurance agreements in which NAICO is the assuming reinsurer.
NAICO has also established a letter of credit in the amount of $500,000 and
pledged cash and investments in this amount to secure reserves assumed under a
reinsurance agreement. Certain insurance companies require CIMI to hold
unremitted net insurance premiums in a fiduciary capacity until disbursed by
CIMI. At March 31, 2010, the total amount of cash and securities restricted
as a result of these arrangements was $35.2 million which was a decrease of
$2.4 million from December 31, 2009.
PAGE 11
NOTE 7. FAIR VALUE MEASUREMENTS
Fair value is defined as the price that would be received to sell an asset
or paid to transfer a liability in an orderly transaction between market
participants at the measurement date. The quality and reliability of the
information used to determine fair values is prioritized into three broad
categories, with the highest priority given to Level 1 inputs and the lowest
priority to Level 3 inputs. These levels are defined as follows:
Level 1 - Quoted prices (unadjusted) in active markets for identical assets
or liabilities that the reporting entity has the ability to access at the
measurement date.
Level 2 - Observable inputs other than quoted prices included within Level 1
for the asset or liability, either directly or indirectly. If an asset or
liability has a specified term, a Level 2 input must be observable for
substantially the full term of the asset or liability.
Level 3 - Unobservable inputs for the asset or liability.
The following tables present information about Chandler USA's assets measured
at fair value on a recurring basis as of March 31, 2010 and December 31, 2009,
and indicates the fair value hierarchy of the valuation techniques utilized to
determine such values. Substantially all of the prices of fixed maturities,
equity securities and short-term investments that are valued as Level 1 or
Level 2 in the fair value hierarchy are received from independent pricing
services utilized by our investment custodians. No liabilities were measured
at fair value at March 31, 2010 or December 31, 2009.
FAIR VALUE MEASUREMENTS AT MARCH 31, 2010
----------------------------------------------------------------
QUOTED PRICES SIGNIFICANT
IN ACTIVE OTHER SIGNIFICANT
MARKETS FOR OBSERVABLE UNOBSERVABLE
IDENTICAL ASSETS INPUTS INPUTS TOTAL
DESCRIPTION (LEVEL 1) (LEVEL 2) (LEVEL 3) FAIR VALUE
-------------------------------------------------------- ---------------- --------------- ---------------- -----------
(In thousands)
Fixed maturities available for sale:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies ............. $ - $ 43,707 $ - $ 43,707
Corporate obligations .............................. - 19,495 - 19,495
Public utilities ................................... - 1,072 - 1,072
Obligations of states and political subdivisions ... - 30,271 - 30,271
---------------- --------------- ---------------- -----------
Total fixed maturities available for sale ........ - 94,545 - 94,545
Equity securities - corporate stock .................. - - 42 42
Short-term investments ............................... - 95 - 95
---------------- --------------- ---------------- -----------
Total .............................................. $ - $ 94,640 $ 42 $ 94,682
================ =============== ================ ===========
FAIR VALUE MEASUREMENTS AT DECEMBER 31, 2009
----------------------------------------------------------------
QUOTED PRICES SIGNIFICANT
IN ACTIVE OTHER SIGNIFICANT
MARKETS FOR OBSERVABLE UNOBSERVABLE
IDENTICAL ASSETS INPUTS INPUTS TOTAL
DESCRIPTION (LEVEL 1) (LEVEL 2) (LEVEL 3) FAIR VALUE
-------------------------------------------------------- ---------------- --------------- ---------------- -----------
(In thousands)
Fixed maturities available for sale:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies ............. $ - $ 41,074 $ - $ 41,074
Corporate obligations .............................. - 32,591 - 32,591
Public utilities ................................... - 2,095 - 2,095
Obligations of states and political subdivisions ... - 27,461 - 27,461
---------------- --------------- ---------------- -----------
Total fixed maturities available for sale ........ - 103,221 - 103,221
Equity securities - corporate stock .................. - - 42 42
Short-term investments ............................... - 380 - 380
---------------- --------------- ---------------- -----------
Total .............................................. $ - $ 103,601 $ 42 $ 103,643
================ =============== ================ ===========
PAGE 12
Prices for fixed maturities available for sale and short-term investments
were provided by various custodians that hold such assets on behalf of Chandler
USA. The custodians utilize independent pricing services to determine prices
for these assets. Management reviews the prices provided but does not conduct
an independent validation of the prices. Any fixed maturities that are not
held by a custodian are priced using non-binding broker quotations. Total
assets priced from broker quotations totaled $377,000 at March 31, 2010 and
December 31, 2009, or 0.4% of total Level 2 assets in each period. There were
no transfers into or out of Level 1 or Level 2 during the quarter ended March
31, 2010.
At March 31, 2010, Chandler USA's equity securities which were measured at
fair value using Level 3 inputs consisted of common stock received in
connection with an unaffiliated entity's conversion to a for-profit
corporation. The fair value of this stock was based upon an analytically
determined valuation from an independent rating organization. The following
table presents additional information about assets measured at fair value
using Level 3 inputs for the quarter ended March 31, 2010:
FAIR VALUE MEASUREMENTS USING SIGNIFICANT THREE MONTHS ENDED
UNOBSERVABLE INPUTS (LEVEL 3) MARCH 31, 2010
------------------------------------------------- ------------------
(In thousands)
Equity Securities - corporate stocks:
Beginning balance ............................. $ 42
Total realized and unrealized gains (losses):
Included in earnings ...................... -
Included in other comprehensive income .... -
Purchases, issuances, sales and settlements:
Purchases ................................. -
Issuances ................................. -
Sales ..................................... -
Settlements ............................... -
Transfers into Level 3 .................... -
Transfers out of Level 3 .................. -
-----------------
Ending balance ................................ $ 42
=================
NOTE 8. FAIR VALUE DISCLOSURES OF FINANCIAL INSTRUMENTS
Estimated fair value amounts have been determined by Chandler USA using
available market information and appropriate valuation methodologies. However,
considerable judgment is necessarily required in interpreting market data to
develop the estimates of fair value. Accordingly, the estimates of fair values
presented herein are not necessarily indicative of the amounts that Chandler
USA could realize in a current market exchange. The use of different market
assumptions and/or estimation methodologies may have a material effect on the
estimated fair value amounts.
A number of Chandler USA's significant assets (including deferred policy
acquisition costs, property and equipment, reinsurance recoverables, prepaid
reinsurance premiums and state insurance licenses) and liabilities (including
unpaid losses and loss adjustment expenses and unearned premiums) are not
considered financial instruments. Based on the short term nature or other
relevant characteristics, Chandler USA has concluded that the carrying value
of other assets and liabilities considered financial instruments, such as cash
equivalents, premiums receivable, policyholder deposits, accrued taxes and
other payables, and premiums payable, approximates their fair value as of
March 31, 2010 and December 31, 2009. The estimated fair values of Chandler
USA's fixed-maturity and equity security investments are disclosed at Note 6.
The fair value of Chandler USA's senior debentures was estimated to be $7.1
million as of March 31, 2010 and December 31, 2009, based on an analytically
determined valuation from an independent rating organization. Chandler USA's
senior debentures have not historically traded regularly, and settlement at
the reported fair value may not be possible. The senior debentures are
redeemable by Chandler USA without penalty or premium, and may be purchased
and cancelled by Chandler USA at a price of less than the sum of the principal
amount and accrued interest at any time. Chandler USA is obligated for $13.4
million principal amount of junior subordinated debentures that mature in 2033
with a fixed interest rate of 9.75%, and $7.2 million principal amount of
junior subordinated debentures that mature in 2034 with a floating rate of
4.10% over LIBOR. The interest rate at March 31, 2010 was 4.35%. The fair
value of Chandler USA's junior subordinated debentures was estimated to be
$22.1 million and $22.0 million at March 31, 2010 and December 31, 2009,
respectively.
PAGE 13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
Some of the statements made in this Form 10-Q 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 collect reinsurance
recoverables; (x) the ability of NAICO to maintain favorable insurance
company ratings; and (xi) various other factors including ongoing litigation
matters.
RESULTS OF OPERATIONS
PREMIUMS EARNED
The following table sets 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 the three month periods ended March 31, 2010 and 2009:
GROSS PREMIUMS EARNED NET PREMIUMS EARNED
--------------------------- ---------------------------
THREE MONTHS ENDED MARCH 31, 2010 2009 2010 2009
---------------------------------- ------------ ------------ ------------ ------------
(In thousands)
INSURANCE PROGRAMS:
Standard lines ................... $ 21,077 $ 22,492 $ 12,975 $ 14,172
Political subdivisions ........... 353 987 225 644
Other ............................ 58 60 68 53
------------ ------------ ------------ ------------
TOTAL ............................ $ 21,488 $ 23,539 $ 13,268 $ 14,869
============ ============ ============ ============
LINES OF INSURANCE:
Workers compensation ............. $ 7,811 $ 7,843 $ 5,034 $ 5,130
Automobile liability ............. 5,944 6,899 4,092 4,750
Other liability .................. 5,685 6,401 2,790 3,364
Automobile physical damage ....... 1,528 2,363 1,023 1,603
Inland marine .................... 252 5 161 3
Property ......................... 243 3 132 3
Other ............................ 25 25 36 16
------------ ------------ ------------ ------------
TOTAL ............................ $ 21,488 $ 23,539 $ 13,268 $ 14,869
============ ============ ============ ============
Gross premiums earned in the first quarter of 2010 decreased $2.1 million or
9% compared to the first quarter of 2009. Net premiums earned decreased $1.6
million or 11% in the first quarter of 2010 compared to the first quarter of
2009.
Gross premiums earned in the standard lines program decreased $1.4 million
or 6% in the first quarter of 2010 compared to the first quarter of 2009.
Gross premiums earned from trucking accounts in this program decreased $1.2
million in the first quarter of 2010. Gross premiums earned for automobile
liability decreased $630,000 in the first quarter of 2010, and gross premiums
earned for automobile physical damage decreased $754,000 the first quarter
of 2010. Net premiums earned decreased $1.2 million or 8% in the first
quarter of 2010 versus the first quarter of 2009, due to the decrease in
gross earned premiums.
PAGE 14
From January 2007 to the second quarter of 2009, the property and inland
marine lines of insurance that were previously written by NAICO in the
standard lines program were written by Praetorian Insurance Company
("Praetorian") through an arrangement between Praetorian and CIMI. Under
this arrangement, CIMI received commission income for the business it produced
for Praetorian. NAICO handles all claims for this business under a separate
claims handling agreement with Praetorian. CIMI and Praetorian terminated
this arrangement effective June 29, 2009, and NAICO resumed writing these
lines of insurance in this program.
Gross premiums earned in the political subdivisions program decreased
$634,000 or 64% in the first quarter of 2010 compared to the first quarter
of 2009. Net premiums earned in the political subdivisions program decreased
$419,000 or 65% in the first quarter of 2010 versus the first quarter of
2009. From January 2007 to the second quarter of 2009, the property and
inland marine lines of insurance in the political subdivisions program that
were previously written by NAICO were written by Praetorian through an
arrangement between Praetorian and CIMI. CIMI and Praetorian terminated this
arrangement effective June 29, 2009. Effective June 1, 2009, the property,
inland marine, automobile liability, automobile physical damage and other
liability lines of insurance in the political subdivisions program that were
previously written by NAICO are being written by Greenwich Insurance Company
("Greenwich") through an arrangement with CIMI. Under this arrangement, CIMI
receives commission income for the business it produces. CIMI is responsible
for the payment of commissions to the producing agents, and is also responsible
for providing underwriting and loss control services for this business. NAICO
handles all claims for this business under a separate claims handling agreement
with Greenwich. NAICO will continue to write workers compensation coverages
for the political subdivisions program and has agreed to reinsure on a quota
share basis 35% of the first $1,000,000 of loss per occurrence of the other
liability business in this program. Because of these changes, NAICO expects
its future premiums earned for the political subdivisions program to decrease
significantly.
NET INVESTMENT INCOME AND NET REALIZED INVESTMENT GAINS
At March 31, 2010, Chandler USA's investment portfolio consisted primarily
of fixed income U.S. Treasury and government agency bonds, high-quality
corporate and tax exempt bonds and certificates of deposit insured by the
FDIC, with approximately 16% 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 related parties on intercompany loans.
Net investment income, excluding interest income from related parties
decreased $28,000 or 4% in the first quarter of 2010 versus the first quarter
of 2009 due primarily to lower interest rates. Cash and invested assets were
$112.5 million at March 31, 2010 compared to $111.1 million at December 31,
2009 and $106.3 million at March 31, 2009. Net interest income from related
parties was $110,000 in the first quarter of 2010 compared to $106,000 in the
first quarter of 2009.
Net realized investment gains were $928,000 in the first quarter of 2010
compared to $384,000 in the first quarter of 2009. The realized gains
resulted from sales of fixed maturities available for sale in the amount of
$25.6 million.
OTHER INCOME
Other income was $492,000 in the first quarter of 2010 and increased $49,000
or 11% compared to the first quarter of 2009. Other income included net
commission income related to business produced by CIMI for insurance companies
other than NAICO totaling $416,000 in the first quarter of 2010 and $297,000
in the first quarter of 2009.
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.
Although such estimates are management's best estimates of the expected
values, the ultimate liability for unpaid claims may vary from these values.
The percentage of losses and loss adjustment expenses to net premiums earned
("loss ratio") was 62.1% for the first quarter of 2010 versus 55.6% in the
first quarter of 2009. During the first quarter of 2010, NAICO experienced
redundant loss reserve development totaling $418,000 which decreased the 2010
loss ratio by 3.2 percentage points. During 2009, NAICO experienced redundant
loss reserve development totaling $330,000 which decreased the 2009 loss ratio
by 2.2 percentage points. Weather-related losses from wind and hail were not
significant in the first quarter of 2010 or 2009.
PAGE 15
POLICY ACQUISITION COSTS
Policy acquisition costs consist of costs associated with the acquisition of
new and renewal business and generally include direct costs such as premium
taxes, commissions to agents and ceding companies and premium-related
assessments and indirect costs such as salaries and expenses of personnel
who perform and support underwriting activities. NAICO also receives ceding
commissions from the reinsurers who assume premiums from NAICO under certain
reinsurance contracts and the ceding commissions are accounted for as a
reduction of policy acquisition costs. Direct policy acquisition costs and
ceding commissions are deferred and amortized over the terms of the policies.
When the sum of the anticipated losses, loss adjustment expenses and
unamortized policy acquisition costs exceeds the related unearned premiums,
including anticipated investment income, a provision for the indicated
deficiency is recorded.
The following table sets forth Chandler USA's policy acquisition costs for
each of the three month periods ended March 31, 2010 and 2009:
THREE MONTHS ENDED MARCH 31,
----------------------------
2010 2009
------------ ------------
(In thousands)
Commissions expense ......................... $ 3,247 $ 3,683
Other premium related assessments ........... 173 267
Premium taxes ............................... 431 455
Excise taxes ................................ 58 67
Other expense ............................... 130 126
------------ ------------
Total direct expenses ....................... 4,039 4,598
Indirect underwriting expenses .............. 1,473 1,430
Commissions received from reinsurers ........ (2,245) (3,023)
Adjustment for deferred acquisition costs ... (461) (89)
------------ ------------
Net policy acquisition costs ................ $ 2,806 $ 2,916
============ ============
Total gross direct and indirect expenses as a percentage of direct written
and assumed premiums were 24.9% for the first quarter of 2010 versus 24.3% for
the first quarter of 2009 and 25.5% for the year ended December 31, 2009.
Commissions expense as a percentage of gross written and assumed premiums was
14.7% for the first quarter of 2010 versus 14.8% for the first quarter of 2009
and the year ended December 31, 2009.
Indirect underwriting expenses increased $43,000 in the first quarter of 2010
compared to the first quarter of 2009, and were 6.7% and 5.8% of total direct
written and assumed premiums in the three month periods ended March 31, 2010
and 2009, respectively. Indirect expenses were 6.4% of total direct written
and assumed premiums in the year ended December 31, 2009. 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.
Commissions received from reinsurers decreased $778,000 in the first quarter
of 2010 compared to the year-ago quarter due to a decrease in reinsurance
premiums ceded to related parties in the 2010 quarter, and to a reduction in
the ceding commission rate on premiums ceded to related parties.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were 13.6% of gross premiums earned and
other income in the first quarter of 2010 versus 12.9% in the 2009 quarter and
12.4% in the year ended December 31, 2009. General and administrative
expenses decreased $110,000 or 4% in the first quarter of 2010 compared to
the 2009 quarter. 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 adjustment expenses based on various factors including
employee counts, salaries, occupancy and specific identification. Because
certain types of expenses are fixed in nature, the percentage of such expenses
to revenues will vary depending on Chandler USA's overall premium volume.
PAGE 16
INTEREST EXPENSE
Interest expense was $577,000 in the first quarter of 2010 compared to
$598,000 in the first quarter of 2009. Substantially all of Chandler USA's
interest expense is related to its outstanding senior debentures and junior
subordinated debentures. The decrease in the 2010 period was due primarily
to lower interest rates during 2010, as a portion of Chandler USA's junior
subordinated debentures were issued with a floating interest rate.
LIQUIDITY AND CAPITAL RESOURCES
In the first quarter of 2010, Chandler USA provided $710,000 in cash from
operations. Premiums receivable decreased $1.1 million and unpaid losses
and loss adjustment expenses increased $997,000. These were partially offset
by an increase in reinsurance recoverable on unpaid losses and loss adjustment
expenses of $862,000 and by a decrease in accrued taxes and other payables of
$613,000. In the first quarter of 2009, Chandler USA provided $3.3 million in
cash from operations. Unpaid losses and loss adjustment expenses increased
$2.6 million, premiums receivable decreased $2.1 million and unearned premiums
increased $1.3 million during the first quarter of 2009. These were partially
offset by an increase in reinsurance recoverable on unpaid losses and loss
adjustment expenses of $2.2 million.
NAICO is required to deposit cash and securities with regulatory agencies in
which it is licensed as a condition of conducting operations in the state. In
addition, NAICO has deposited cash and securities into a trust account as
collateral for a reinsurance agreement in which NAICO is the assuming
reinsurer. Certain insurance companies require CIMI to hold unremitted net
insurance premiums in a fiduciary capacity until disbursed by CIMI. At March
31, 2010, the total amount of cash and securities restricted as a result of
these arrangements was $35.2 million which was a decrease of $2.4 million
from December 31, 2009.
At March 31, 2010, Chandler USA's parent company, Chandler Insurance Company,
Ltd., owed approximately $12.2 million to Chandler USA versus $12.7 million at
December 31, 2009 under an Intercompany Credit Agreement (the "Credit
Agreement") covering intercompany loans between the parties. The Credit
Agreement requires interest to be paid at the prime interest rate published in
The Wall Street Journal each month, and balances owed by either party are
payable at any time upon demand.
During March 2001, Chandler USA entered into a $3.8 million sale and
leaseback transaction for certain owned equipment for a three year term.
During March 2004 and March 2007, the lease was extended for additional three
year terms, and during March 2010, the lease was extended for an additional
three years with monthly rental installments equal to the sum of (i) $10,929
plus (ii) interest on the unpaid lease balance at 1% over JP Morgan Chase
Bank prime which was 4.25% at March 31, 2010. The interest rate is subject
to a minimum rate of 5.5% beginning in March 2010. Chandler USA has the
option to repurchase the equipment at the end of the lease for approximately
$1.5 million (the "Balloon Payment"), or may elect to have the lessor sell the
equipment. If the election to sell the equipment is made, Chandler USA would
retain any proceeds exceeding the Balloon Payment. If the proceeds were less
than the Balloon Payment, Chandler USA would be required to pay the difference
between the proceeds and the Balloon Payment, not to exceed approximately
$1.2 million.
Chandler USA is a holding company receiving cash principally through
borrowings, subsidiary dividends and other payments, subject to various
regulatory restrictions. The capacity of insurance companies to write
insurance is based on maintaining liquidity and capital resources sufficient
to pay claims and expenses as they become due. The primary sources of
liquidity for Chandler USA's subsidiaries are funds generated from insurance
premiums, investment income, capital contributions from Chandler USA and
proceeds from sales and maturities of portfolio investments. The principal
expenditures are payment of losses and loss adjustment expenses, insurance
operating expenses and commissions.
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.
PAGE 17
As of December 31, 2009, NAICO had statutory earned surplus of $15.5
million. Applying the Oklahoma statutory limits described above, the maximum
shareholder dividend NAICO may pay in 2010 without the approval of the
Oklahoma Department of Insurance is $5.4 million. NAICO paid cash
shareholder dividends to Chandler USA totaling $300,000 during the first
quarter of 2010. During the first quarter of 2009, NAICO paid cash
shareholder dividends to Chandler USA totaling $500,000.
In addition to the statutory limits described above, the amount of
shareholder dividends and other payments to affiliates 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.
Historically, NAICO has played a significant role in the servicing of debt
and other obligations of Chandler USA through the payment of shareholder
dividends. These obligations include $7.0 million of 8.75% senior debentures
due in 2014, $13.4 million of 9.75% junior subordinated debentures due in
2033, $7.2 million of floating rate junior subordinated debentures due in
2034 and the obligations under the sale and leaseback transaction discussed
previously. To the extent that the restrictions discussed previously limit
NAICO's ability to pay shareholder dividends or other payments to Chandler
USA, Chandler USA's ability to satisfy the debt obligations may also be
limited.
The Patient Protection and Affordable Care Act and the Health Care and
Education Reconciliation Act of 2010 (collectively the "Acts") were signed
into law during March 2010. Many of the provisions in the Acts require the
issuance of additional guidance and do not become operative until future
years. NAICO does not write accident and health insurance. To the extent
that the Acts adversely impact medical costs, NAICO's liability and workers
compensation insurance business could be affected. At this time, we do not
expect the Acts to have a material impact on our consolidated financial
statements.
LITIGATION
In October 1999, NAICO provided surety bonds for Gulsby Engineering, Inc.
("Gulsby") in connection with contracts between Gulf Liquids New River
Project, LLC ("Gulf Liquids") and Gulsby for the construction of two gas
processing plants in Louisiana. During 2001, Gulsby became unable to pay
various vendors resulting in payments to vendors by NAICO totaling
$20,182,499. In August 2001, NAICO filed suit in federal court in Louisiana
alleging that Gulf Liquids had breached its obligations under the bonds by
materially altering certain contracts and that as a result, NAICO was
exonerated on the bonds and should recover the amounts paid to vendors. In
the fall of 2001, Gulsby and Bay Limited, another contractor with whom Gulsby
had entered into a joint venture for the construction of other gas processing
plants for Gulf Liquids, filed lawsuits relating to those plants in Houston,
Texas. Gulf Liquids filed original actions and counterclaims. NAICO
intervened in the Texas lawsuits and, in addition, sued Williams Energy
Marketing and Trading (which later became Williams Power Company, Inc.)
("Williams") alleging fraud, breach of contract, tortious interference with
contractual relations, conspiracy and alter ego. These claims were asserted
against both Gulf Liquids and Williams. Gulf Liquids asserted counterclaims
alleging breach of contract against NAICO and requesting contractual and
statutory damages ranging from $40 million to $80 million. The cases were
consolidated for trial in the 215th Judicial District Court in Harris County,
Texas. On August 1, 2006, the jury trial concluded in Harris County, Texas,
related to the construction of two gas processing plants in Louisiana. The
amounts the jury found owing to NAICO included approximately $20.2 million in
actual damages and $70.0 million in punitive damages. See Note 4 of Notes to
Interim Consolidated Financial Statements for a discussion of this jury
verdict.
On January 28, 2008, the court entered a final judgment denying Gulf Liquid's
claims against NAICO and Gulsby, denying all of NAICO's claims against Gulf
Liquids and Williams, and entering judgment for Gulsby against Gulf Liquids
for $15,651,927 plus interest at 7.25% compounded annually from January 28,
2008 until paid. The court also ordered Gulf Liquids to pay Gulsby's taxable
court costs, estimated at $100,000. Gulf Liquids has appealed the judgment
entered in favor of Gulsby and the denial of its claims against NAICO and
Gulsby. NAICO has appealed the trial court's denial of its claims against
Gulf Liquids and Williams and seeks entry of judgment upon the jury verdicts
for the amounts the jury found should be awarded to NAICO. Gulsby has also
appealed the trial court's final judgment, contending that judgment should be
entered in its favor against Gulf Liquids and Williams in accordance with the
jury verdicts. The recoverable amounts deducted from Chandler USA's net
liability for losses and loss adjustment expenses related to this litigation
were approximately $10.1 million at March 31, 2010 and December 31, 2009.
PAGE 18
ITEM 4T. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
As of the end of the period covered by this report and pursuant to Rule
13a-15 of the Securities Exchange Act of 1934 (the "Exchange Act"), Chandler
USA's management, including the Chief Executive Officer and Chief Financial
Officer, conducted an evaluation of the effectiveness and design of Chandler
USA's disclosure controls and procedures (as that term is defined in Rules
13a-15(e) and 15d-15(e) of the Exchange Act). Based upon that evaluation,
Chandler USA's Chief Executive Officer and Chief Financial Officer concluded,
as of the end of the period covered by this report, that Chandler USA's
disclosure controls and procedures were effective in recording, processing,
summarizing and reporting information required to be disclosed by Chandler
USA, within the time periods specified in the Securities and Exchange
Commission's rules and forms.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
In addition and as of the end of the period covered by this report, there
have been no changes in internal control over financial reporting (as
defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) during the
quarter to which this report relates that have materially affected or are
reasonably likely to materially affect the internal control over financial
reporting.
PART II. OTHER INFORMATION
-----------------
Item 1. LEGAL PROCEEDINGS
-----------------
Chandler USA and its subsidiaries are not parties to any material
litigation other than as is routinely encountered in their
respective business activities. While the outcome of these matters
cannot be predicted with certainty, Chandler USA does not expect
these matters to have a material adverse effect on its financial
condition, results of operations or cash flows. See Note 4 of Notes
to Interim Consolidated Financial Statements for a discussion of a
favorable jury verdict in civil litigation regarding certain surety
bond claims.
Item 1A. RISK FACTORS
------------
There have been no material changes from risk factors previously
disclosed in our Annual Report on Form 10-K for the year ended
December 31, 2009.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
-----------------------------------------------------------
None.
Item 3. DEFAULTS UPON SENIOR SECURITIES
-------------------------------
None.
Item 4. RESERVED
--------
Item 5. OTHER INFORMATION
-----------------
None.
Item 6. EXHIBITS
--------
31.1 Rule 13a-14(a)/15d-14(a) Certifications.
32.1 Section 1350 Certifications.
PAGE 19
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: May 12, 2010 CHANDLER (U.S.A.), INC.
By: /s/ W. Brent LaGere
--------------------------------------
W. Brent LaGere
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
By: /s/ Mark C. Hart
--------------------------------------
Mark C. Hart
Senior Vice President - Finance, Chief
Financial Officer and Treasurer
(Principal Accounting Officer)
