-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, NWbXqhfJCV8gDicQHrQj5CrfqH1z8YqnRC0Zgn2xL+CHde3KiIzkhsG2ZhqeTKnK EoQnwPJN5Eo30gGJ6FxBhg== 0000792854-98-000004.txt : 19980331 0000792854-98-000004.hdr.sgml : 19980331 ACCESSION NUMBER: 0000792854-98-000004 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980330 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: CHANDLER INSURANCE CO LTD CENTRAL INDEX KEY: 0000792854 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 000000000 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-15286 FILM NUMBER: 98579425 BUSINESS ADDRESS: STREET 1: 5TH FLR ANDERSON SQUARE STREET 2: PO BOX 1854 CITY: GRAND CAYMAN CAYMAN STATE: E9 ZIP: 00000 BUSINESS PHONE: 3459498177 MAIL ADDRESS: STREET 1: 5TH FLOOR ANDERSON SQUARE STREET 2: P O BOX 1854 CITY: GRAND CAYMAN STATE: E9 10-K405 1 =============================================================================== UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------------------- FORM 10-K X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE --- SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 1997 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE --- SECURITIES EXCHANGE ACT OF 1934 For the Transition Period from ________ to ________ Commission File Number: 0-15286 CHANDLER INSURANCE COMPANY, LTD. (Exact name of registrant as specified in its charter) CAYMAN ISLANDS NONE (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 5TH FLOOR ANDERSON SQUARE N/A P.O. BOX 1854 (Zip Code) GRAND CAYMAN, CAYMAN ISLANDS B.W.I. (Address of principal executive offices) Registrant's telephone number, including area code: 345-949-8177 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: COMMON SHARES, $1.67 PAR VALUE Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO ----- ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. X --- The aggregate market value of the voting stock held by non-affiliates of the registrant on February 28, 1998 was $15,829,488 (all currency is expressed in U.S. dollars). See "ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT" regarding registrant's assumptions about affiliates and possible changes in control. The number of common shares, $1.67 par value, of the registrant outstanding on February 28, 1998 was 6,941,708, which includes 494,617 common shares owned by a subsidiary of the registrant which are eligible to vote, and 1,660,125 common shares which were rescinded through litigation and are held by a court. See "ITEM 3. LEGAL PROCEEDINGS". DOCUMENTS INCORPORATED BY REFERENCE Registrant does not incorporate by reference in this report any annual report, proxy statement, or Rule 424 prospectus. =============================================================================== PAGE 1 PART I FORWARD-LOOKING STATEMENTS Some of the statements made in this Form 10-K report, as well as statements made by Chandler Insurance Company, Ltd. (the "Company") in periodic press releases, oral statements made by the Company's officials to analysts and shareholders in the course of presentations about the Company and conference calls following earnings releases, constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Such factors include, among other things, (i) general economic and business conditions; (ii) interest rate changes; (iii) competition and regulatory environment in which the Company operates; (iv) claims frequency; (v) claims severity; (vi) the number of new and renewal policy applications submitted by the Company's agents; and (vii) other factors such as the ongoing litigation matters involving a significant concentration of ownership of common stock. ITEM 1. BUSINESS GENERAL The Company is a holding company organized and domiciled in the Cayman Islands whose wholly owned subsidiaries are engaged in various property and casualty insurance and reinsurance operations. The insurance products are underwritten by National American Insurance Company ("NAICO"), a Nebraska insurance company that is a wholly owned subsidiary of the Company. NAICO primarily provides property and casualty coverage for businesses in various industries, political subdivisions, nonstandard private-passenger automobiles and surety bonds for small contractors. NAICO is licensed in 44 of the United States and the District of Columbia and is authorized by the United States Department of the Treasury to write surety bonds for contractors on federal projects. NAICO is rated "A- (Excellent)" by A.M. Best Company. A.M. Best Company's ratings range from the highest rating of "A++ (Superior)" to the lowest rating of "F (in Liquidation)". These ratings are an independent opinion of a company's financial strength, operating performance and ability to meet its obligations to policyholders. Chandler Insurance (Barbados), Ltd. ("Chandler Barbados"), a Barbados company and a wholly owned subsidiary of the Company, principally reinsures risks underwritten by NAICO. NAICO retains a portion of each risk, then transfers the balance to other reinsurance companies including Chandler Barbados. Such reinsurance arrangements are governed by reinsurance contracts between NAICO and each of its reinsurers and Chandler Barbados and each of its reinsureds. One of the Company's wholly owned subsidiaries, LaGere & Walkingstick Insurance Agency, Inc. ("L&W"), an independent insurance agency based in Chandler, Oklahoma, represents various insurance companies, including NAICO, that provide a variety of property-casualty, life and accident and health coverages. L&W also acts as a surplus lines broker specializing in risk management and brokering insurance for high risk ventures. The Company conducts its business from the Cayman Islands in the British West Indies and is not subject to regulation as an insurance company in any jurisdiction within the United States of America. The Company is, however, subject to certain regulations of The Monetary Authority in the Cayman Islands. Chandler Barbados is subject to similar Barbados regulations. See "Regulation". Although Chandler Barbados is not subject to the minimum capital, audit, reporting and other requirements imposed by regulation upon United States reinsurance companies, as a foreign reinsurer it is required by the United States companies it reinsures to secure its reinsurance obligations by depositing acceptable securities in a trust for the benefit of the company ceding such obligations or by letters of credit in favor of the ceding company. See "Trust Arrangements and Special Deposits". NAICO is subject to minimum capital, audit, reporting, dividend and other requirements imposed by regulation upon United States insurance companies. See "Regulation". STANDARD PROPERTY-CASUALTY PROGRAM Insurance products offered in NAICO's standard property-casualty program include workers compensation, automobile liability and physical damage, general and umbrella liability and property coverages. Target industries or classes of business include nursing homes, home healthcare, construction, retail, manufacturers, wholesalers and service and retail companies. This business is principally written in the states of Oklahoma, Texas, Illinois and Georgia. POLITICAL SUBDIVISIONS PROGRAM In 1990, NAICO began writing property-casualty coverage for school districts in Oklahoma. L&W had produced this business since 1983 for unrelated insurers. The coverages offered include workers compensation, automobile liability, general liability, property and school board legal liability. PAGE 2 In 1991, NAICO began writing property-casualty insurance for municipalities. The coverages include automobile and general liability, property and public officials liability insurance. Since 1991, NAICO has restricted its underwriting to Oklahoma municipalities. In 1995, NAICO began offering workers compensation in addition to the other coverages. In mid-1995, NAICO began insuring counties in Oklahoma for automobile and general liability, property and public officials liability. SURETY BOND PROGRAM NAICO writes surety bonds, commonly called performance bonds, to secure the performance of contractors and suppliers on construction projects. Individual bonds generally do not exceed $4.0 million and work in progress for an individual contractor generally does not exceed $7.0 million. A substantial portion of this business is written in Oklahoma, Texas, New Mexico and California. NAICO also writes court bonds which guarantee that the principal will discharge obligations set by the court, as well as various types of miscellaneous bonds. NONSTANDARD PRIVATE-PASSENGER AUTOMOBILE PROGRAM In late 1993, NAICO began writing nonstandard private-passenger automobile liability and automobile physical damage in Oklahoma. Policy limits for automobile liability are $10,000 each person and $20,000 each loss occurrence for bodily injury and $10,000 for property damage. During mid-1994, NAICO began writing a similar program in California and Arizona. California and Arizona policy limits are $15,000 each person and $30,000 each loss occurrence for bodily injury and $10,000 for property damage. The Arizona and California portions of the program are produced by an underwriting manager headquartered in California. During the second quarter of 1997, management reviewed the underwriting performance of the California portion of the program and concluded that it would be in the Company's best interest to substantially reduce its underwriting risk. Effective July 1, 1997, NAICO entered into a 100% quota share reinsurance agreement with Underwriters Reinsurance Company to fully reinsure the risk. In December 1997, the reinsurance contract was amended and Jefferson Insurance Company of New York replaced Underwriters Reinsurance Company. The Oklahoma and Arizona portions of the program were discontinued in 1997. GROUP ACCIDENT AND HEALTH PROGRAM Effective January 1, 1996, NAICO began offering excess accident and health coverage for small to medium-sized employers that self-insure a portion of their company medical plans. This business is generally written in Oklahoma and Texas. VOLUNTARY AND INVOLUNTARY POOLS, ASSOCIATIONS AND ASSIGNED RISKS NAICO participates in various voluntary and involuntary insurance pools and associations ("Pools") covering workers compensation risks for insureds who were unable to purchase this coverage from an insurance company on a voluntary basis. In addition, NAICO receives direct assignments to write workers compensation for such insureds in lieu of participating in the Pools. AGENCY AND BROKERAGE L&W is appointed by insurers to solicit applications for policies of insurance primarily in Oklahoma. L&W represents diverse personal and commercial lines insurance companies regarding property-casualty insurance. L&W also markets individual and group life, medical and disability income coverage. Major target classes of business are political subdivisions, healthcare facilities, transportation companies, manufacturers, contractors, oil & gas business, retailers, wholesalers and service organizations. A large portion of certain classes of business produced by L&W is placed with NAICO. L&W also acts as a surplus lines broker specializing in risk management and brokering insurance for high risk ventures. L&W places direct agency business as well as business from other agents with specialty insurance companies. RISK MANAGEMENT SERVICES In October 1995, the Company purchased all of the capital stock of Network Administrators, Inc. ("Network"). Network is a Texas corporation based in Dallas, Texas and is a third-party administrator involved in structuring and administering partially self-insured group accident and health plans for employers. Network's operations were consolidated into a joint venture in the third quarter of 1997. Effective December 31, 1997, Network's participation in the joint venture was terminated. Network no longer functions as a third-party administrator. Since 1987, NAICO has offered risk management services on an unbundled basis to certain insurance customers. In 1995, NAICO and L&W began to offer unbundled risk management services and flexible risk transfer products using the trade name "Chandler Risk Services". Such products and services are offered by NAICO, L&W or other subsidiaries of the Company and include claim management, loss control, reinsurance, policy issuance and other risk management services. PAGE 3 UNDERWRITING AND CLAIMS Independent insurance agents submit applications for insurance coverage for prospective customers to NAICO and, for certain insurance programs, to underwriting managers. NAICO personnel and/or the underwriting managers review a prospective risk in accordance with specific underwriting guidelines set by NAICO. If the risk is approved and coverage is accepted by the insured, a NAICO insurance policy is issued. NAICO's largest unaffiliated independent insurance agent during 1995 was responsible for producing $11.0 million of NAICO's direct written and assumed premiums. There were no unaffiliated independent insurance agents that produced 10% or more of NAICO's direct written and assumed premiums during 1996 or 1997. The underwriting managers are independent contractors to NAICO and are compensated on a commission basis for their underwriting services. Each underwriting manager is responsible for all commissions payable to any independent insurance agent who produces the insurance business. In addition, the underwriting managers pay all salaries and expenses of personnel who perform and support the underwriting activities as well as other incidental expenses. NAICO's largest underwriting manager was responsible for underwriting $11.5 million, $11.9 million and $12.3 million of NAICO's direct written and assumed premiums for the California and Arizona portions of the nonstandard private-passenger automobile program in 1995, 1996 and 1997, respectively. Premiums receivable and currently due from this underwriting manager were $596,000 and $612,000 at December 31, 1996 and 1997, respectively. NAICO's claim department reviews and administers all claims. When a claim is received it is reviewed and assigned to an in-house claim adjuster based on the type and geographic location of the claim, its severity and the class of business. NAICO's claim department is responsible for reviewing each claim, obtaining necessary documentation and establishing loss and loss adjustment expense reserves. All claims are monitored by the in-house claims staff which handle or supervise the claims, coordinate with outside legal counsel and independent claims adjusters if necessary, and process the claims to conclusion. REINSURANCE In the ordinary course of business, NAICO cedes insurance risks and a portion of the insurance premiums to its reinsurers under various reinsurance contracts that cover individual risks (facultative reinsurance) or entire classes of business (treaty reinsurance). Reinsurance provides greater diversification of insurance risk associated with business written and also reduces NAICO's exposure from high policy limits or from catastrophic events and hazards of an unusual nature. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. NAICO has structured separate reinsurance programs for surety bonds, property, workers compensation, casualty (including automobile liability and physical damage, general liability, umbrella liability, and related professional liability) and group accident and health. Chandler Barbados reinsures NAICO for a portion of the risk on the surety bonds, workers compensation and casualty reinsurance programs. Under the 1997 workers compensation reinsurance program, the combined net retention for NAICO and Chandler Barbados was $1,000,000 of loss per occurrence. Effective February 1, 1998, the combined net retention was reduced to $500,000 of loss per occurrence. The combined net retention under the 1997 casualty reinsurance program was $500,000 of loss per occurrence. Effective February 1, 1998, the combined net retention was reduced to $250,000 of loss per occurrence. The combined net retention under the surety bond reinsurance program is $500,000 per bond or per principal (e.g. contractor). NAICO retains 30% of the first $500,000 of risk for each loss per location under its property reinsurance program. Under the group accident and health program, NAICO retains the first $50,000 in excess of the self-insured retention for each insured person, each policy, and the first $100,000 (or the first $250,000 for cases exceeding 400 covered employees) of losses in excess of the self-insured aggregate retention. In addition, NAICO purchases catastrophe protection to limit its retention for single loss occurrences involving multiple policies and/or policyholders, resulting from perils such as floods, winds and severe storms. NAICO also purchases facultative reinsurance when it writes a risk with limits of liability exceeding the maximum limits of its treaties or when it otherwise considers such action appropriate. Treaty reinsurance may be ceded under treaties on both a pro rata or proportional basis (where the reinsurer shares proportionately in premiums and losses) and an excess of loss basis (where only losses above a specific amount are reinsured). The availability, costs and limits of reinsurance purchased can vary from year to year based upon prevailing market conditions, reinsurers' underwriting results and NAICO's desired retention levels. A majority of NAICO's reinsurance programs renew on January 1, April 1 and July 1 of each year. NAICO renewed all January 1 reinsurance programs. At the present time, NAICO expects to renew the reinsurance programs on April 1 and July 1. PAGE 4 In formulating its reinsurance programs, NAICO considers numerous factors, including the financial stability of the reinsurer, its ability to provide sufficient collateral if required, coverage offered and price. The following table sets forth certain information related to NAICO and NAICO Indemnity (Cayman), Ltd.'s ("NAICO Indemnity") five largest reinsurers (excluding Chandler Barbados) by net reinsurance recoverables as of December 31, 1997. NAICO Indemnity is a Cayman Islands company and is a wholly owned subsidiary of the Company which is in a run-off position.
NET CEDED A.M. REINSURANCE REINSURANCE BEST CO. NAME OF REINSURER RECOVERABLE (1) PREMIUMS RATING - --------------------------------- --------------- --------------- - -------- (Dollars in thousands) Jefferson Insurance Company of New York.......... $ 4,523 $ 7,473 A National Union Fire Insurance Company of Pittsburgh (2).... 3,930 - A++ SCOR Reinsurance Company......... 3,831 4,756 A+ National American Insurance Company of California........ 1,123 - B++ Transamerica Occidental Life Insurance Company....... 1,122 11 A+ --------------- --------------- Top five reinsurers.......... $ 14,529 $ 12,240 =============== =============== All reinsurers............... $ 23,607 $ 26,222 =============== =============== Percentage of total represented by top five reinsurers....... 61.5% 46.7% - --------------------------------- (1) Includes losses and loss adjustment expenses paid and outstanding, unpaid losses and loss adjustment expenses and unearned premium reserves recoverable from reinsurers as of December 31, 1997. (2) National Union Fire Insurance Company of Pittsburgh, Pennsylvania assumed the reinsurance obligations of DuraRock Underwriters, Ltd. effective March 31, 1993. See Notes to Consolidated Financial Statements.
Reinsurance contracts do not relieve an insurer from its obligation to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company; consequently, allowances are established for amounts deemed uncollectible. During 1995, 1996 and 1997, NAICO charged to policy acquisition costs $440,000, $2.1 million and $527,000, respectively, in uncollectible reinsurance recoverables from unaffiliated reinsurers. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS". LINES OF INSURANCE UNDERWRITTEN The following table shows the percentage of net premiums earned by line of insurance underwritten by the Company during the period indicated. The term "net premiums earned" means net premiums written less the increases or plus the decreases in the unearned premium reserve for the unexpired portion of the policy term beyond the current accounting period. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS".
YEAR ENDED DECEMBER 31, - ------------------------------------------ 1993 1994 1995 1996 1997 ------ ------ ------ ------ - ------ Workers compensation.................. 42% 48% 46% 48% 47% Automobile liability.................. 16 17 19 20 16 Other liability....................... 4 6 8 10 13 Surety and fidelity................... 36 24 18 11 12 Automobile physical damage............ 1 3 7 8 6 Accident and health................... - 1 - - 3 Property.............................. 1 1 2 2 2 Inland marine......................... - - - 1 1 ------ ------ ------ ------ - ------ Total.............................. 100% 100% 100% 100% 100% ====== ====== ====== ====== ======
LOSS AND UNDERWRITING EXPENSE RATIOS The combined loss and underwriting expense ratio is the traditional measure of underwriting experience for property-casualty insurance companies. It is the sum of the ratios of (i) incurred losses and loss adjustment expenses to net premiums earned ("loss ratio") and (ii) underwriting expenses to net premiums written and assumed ("underwriting expense ratio"). PAGE 5 The following table shows the underwriting experience of the Company for the periods indicated by line of insurance written. Adjustments to reserves made in subsequent periods are reflected in the year of adjustment. In the following table, incurred losses have been defined to include paid losses and loss adjustment expenses, net changes in case reserves for losses and loss adjustment expenses and net changes in reserves for incurred but not reported losses and loss adjustment expenses. See also "Reserves" and "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS".
YEAR ENDED DECEMBER 31, ------------------------------------------------ 1993 1994 1995 1996 1997 -------- -------- -------- -------- - -------- (Dollars in thousands) Workers compensation: Net premiums earned.........$32,675 $39,183 $37,066 $42,813 $44,954 Loss ratio.................. 74% 65% 62% 53% 66% Automobile liability: Net premiums earned.........$12,727 $13,551 $15,498 $17,581 $15,593 Loss ratio.................. 104% 108% 74% 98% 89% Other liability: Net premiums earned.........$ 3,380 $ 4,759 $ 6,579 $ 8,656 $12,209 Loss ratio.................. 84% 63% 43% 60% 49% Surety and fidelity: Net premiums earned.........$28,862 $19,950 $14,237 $10,123 $11,256 Loss ratio.................. 39% 51% 56% (1)% 9% Automobile physical damage: Net premiums earned.........$ 732 $ 2,342 $ 5,881 $ 6,788 $ 5,726 Loss ratio.................. 50% 64% 68% 74% 60% Accident and health: Net premiums earned.........$ 384 $ 754 $ 230 $ 564 $ 2,529 Loss ratio.................. 83% 70% (49)% 56% 43% Property: Net premiums earned.........$ 530 $ 982 $ 1,369 $ 1,467 $ 1,912 Loss ratio.................. 58% 80% 73% 114% 74% Inland marine: Net premiums earned.........$ 10 $ 76 $ 227 $ 1,294 $ 500 Loss ratio.................. (945)% (154)% 84% 115% 195% Total: Net premiums earned.........$79,300 $81,597 $81,087 $89,286 $94,679 Loss ratio.................. 66% 69% 62% 60% 61% Underwriting expense ratio (1)............... 41% 34% 39% 46% 39% -------- -------- -------- -------- - -------- Combined loss and underwriting expense ratio (1)............... 107% 103% 101% 106% 100% ======== ======== ======== ======== ======== - -------------------------------- (1) Litigation costs are not considered underwriting expenses; therefore, such costs have been excluded from this ratio. The 1996 underwriting expense ratio was increased by 4 percentage points by a reinsurance arbitration adjustment and the termination of relations with the Company's former surety bond underwriting manager. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS".
RESERVES Insurance companies provide in their financial statements reserves for unpaid losses and loss adjustment expenses which are estimates of the expense of investigation and settlement of all reported and unreported losses under their previously issued insurance policies and/or reinsurance contracts. In estimating reserves, insurance companies use various standardized methods based on historical experience and payment and reporting patterns for the type of risk involved. The application of these methods necessarily involves subjective determinations by the personnel of the insurance company. Inherent in the estimates of the ultimate liability for unpaid claims are expected trends in claim severity, claim frequency and other factors that may vary as claims are settled. The amount of and uncertainty in the estimates are affected by such factors as the amount of historical claims experience relative to the development period for the type of risk, knowledge of the actual facts and circumstances, and the amount of insurance risk retained. The ultimate cost of insurance claims can be adversely affected by increased costs, such as medical, repair expenses, costs of providing legal defense for policyholders, increased jury awards, and court decisions and legislation that expand insurance coverage after the insurance policy was priced and sold. Accordingly, the loss and loss adjustment expense reserves may not accurately predict an insurance company's ultimate liability for unpaid claims. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS". PAGE 6 NAICO periodically reviews the reserve estimates relating to insurance business written or assumed by NAICO and Chandler Barbados and the methods used to arrive at such reserve estimates. NAICO also retains independent professional actuaries who review such reserve estimates and methods. Any changes in the estimates are reflected in current operating results. Salvage and subrogation recoverables are accrued using the "case basis" method for large recoverables and statistical estimates based on historical experience for smaller recoverables. Recoverable amounts deducted from the Company's net liability for losses and loss adjustment expenses were approximately $3.6 million and $3.8 million at December 31, 1996 and 1997, respectively. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" and Notes to Consolidated Financial Statements. Chandler Barbados reports its reserves on the basis of United States generally accepted accounting principles ("U.S. GAAP"), which does not differ from the manner in which they are reported to The Monetary Authority of the Cayman Islands and the Supervisor of Insurance of Barbados. NAICO's statutory- based reserves do not differ from its U.S. GAAP reserves. Neither NAICO nor Chandler Barbados discounts its reserves for unpaid losses and loss adjustment expenses. NAICO participates in various Pools covering workers compensation risks for insureds who were unable to purchase this coverage from an insurance company on a voluntary basis. In addition, NAICO receives direct assignments to write workers compensation for such insureds in lieu of participating in the Pools. The consolidated financial statements reflect the reserves for unpaid losses and loss adjustment expenses and net premiums earned from its participation in the Pools and from these residual market direct assignments. The loss settlement period on insurance claims for property damage is relatively short. The more severe losses for bodily injury and workers compensation claims have a much longer loss settlement period and may be paid out over several years. It is often necessary to adjust estimates of liability on a loss either upward or downward between the time a claim arises and the time of payment. Workers compensation indemnity benefit reserves are determined based on statutory benefits described by state law and are estimated based on the same factors generally discussed above, with actuarial input, which may include, where state law permits, inflation adjustments for rising benefits over time. Generally, the more costly automobile liability claims involve one or more severe bodily injuries or deaths. The ultimate cost of these types of claims is dependent on various factors including the relative liability of the parties involved, the number and severity of injuries, and the legal jurisdiction where the incident occurred. The following table sets forth a reconciliation of the beginning and ending reserves for losses and loss adjustment expenses which are net of reinsurance deductions for the years indicated.
YEAR ENDED DECEMBER 31, - -------------------------------------------------------------- 1993 1994 1995 1996 1997 ---------- - ---------- ---------- ---------- ---------- (Dollars in thousands) Net balance before provision for uncollectible reinsurance and reclassification of Pool liabilities at beginning of year (1)................ $ 119,963 $ 98,871 $ 86,512 $ 70,006 $ 53,048 ---------- - ---------- ---------- ---------- ---------- Net losses and loss adjustment expenses incurred related to: Current year..................................... 47,265 54,753 50,975 53,314 53,704 Prior years...................................... 5,239 1,119 (432) 77 3,808 ---------- - ---------- ---------- ---------- ---------- Total......................................... 52,504 55,872 50,543 53,391 57,512 ---------- - ---------- ---------- ---------- ---------- Net paid losses and loss adjustment expenses related to: Current year..................................... (12,179) (18,433) (21,106) (23,836) (22,214) Prior year....................................... (61,417) (49,798) (45,943) (46,513) (36,838) ---------- - ---------- ---------- ---------- ---------- Total......................................... (73,596) (68,231) (67,049) (70,349) (59,052) ---------- - ---------- ---------- ---------- ---------- Net balance before provision for uncollectible reinsurance and reclassification of Pool liabilities at end of year (1)...................... 98,871 86,512 70,006 53,048 51,508 Reclassification of Pool liabilities (1)............... 15,694 11,382 11,382 11,382 11,382 Adjustments to reinsurance recoverables on unpaid losses for uncollectible reinsurance................ 814 698 629 777 1,163 ---------- - ---------- ---------- ---------- ---------- Net balance at end of year............................. $ 115,379 $ 98,592 $ 82,017 $ 65,207 $ 64,053 - ------------------------------------------------------- ========== ========== ========== ========== ========== (1) The reclassification of Pool liabilities represents the Company's proportionate share of unpaid losses resulting from NAICO's participation in various Pools. Subsequent to December 31, 1994, changes in the estimate for and payments of Pool liabilities are included with changes in the estimate for and payments of all other claim liabilities. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" and Notes to Consolidated Financial Statements.
PAGE 7 The following table represents the development of net balance sheet reserves for 1988 through 1997. The top line of the table shows the net reserves at the balance sheet date for each of the indicated years. This represents the estimated amounts of claims and claim expenses, net of reinsurance deductions, arising in the current and all prior years that are unpaid at the balance sheet date including the net reserve for incurred but not reported claims. The upper portion of the table shows the cumulative net amounts paid as of successive years with respect to that reserve liability. The estimate changes as more information becomes known about the frequency and severity of claims for individual years. The next portion of the table shows the re-estimated amount of the previously recorded net reserve based on experience as of the end of each succeeding year. The heading "net cumulative (deficiency) redundancy" represents the cumulative aggregate change in the estimates over all prior years. The last portion of the table provides a reconciliation of the net amounts to the gross amounts before any deductions for reinsurance for the last six years presented. In evaluating the information in the following table, it should be noted that each amount includes the effects of all changes in amounts for prior periods. For example, the amount of the deficiency recorded in 1991 for claims that occurred in 1988 will be included in the cumulative deficiency amount for years 1988, 1989, 1990 and 1991. This table does not present accident or policy year development data. Conditions and trends that have affected development of the liability in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future deficiencies or redundancies based on this table.
DEVELOPMENT OF RESERVES AS OF DECEMBER 31, - -------------------------------------------------------------------------------- - ----------------------------- 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 ---------- ---------- ---------- ---------- ---------- - ---------- ---------- ---------- ---------- ---------- (Dollars in thousands) Net reserve for unpaid losses and loss adjustment expenses (1).......$ 30,274 $ 62,738 $ 125,348 $ 144,430 $ 119,963 $ 99,685 $ 98,592 $ 82,017 $ 65,207 $ 64,053 Net paid (cumulative) as of One year later..... 15,070 35,715 67,898 78,323 61,417 49,798 45,943 46,513 36,837 Two years later.... 29,561 71,176 114,793 120,319 94,047 73,225 72,718 65,754 Three years later.. 44,893 89,987 136,134 144,900 109,885 90,909 85,006 Four years later... 51,564 98,556 150,709 155,816 122,757 98,193 Five years later... 53,771 104,545 155,589 165,357 127,725 Six years later.... 55,295 106,418 159,396 168,509 Seven years later.. 55,897 108,216 160,358 Eight years later.. 56,267 108,542 Nine years later... 56,622 Net liability re-estimated as of (1) One year later..... 33,432 84,534 144,798 160,938 125,202 100,804 98,160 82,094 69,015 Two years later.... 41,558 100,219 156,986 163,100 127,557 101,467 96,279 84,023 Three years later.. 51,887 106,624 157,264 166,807 129,449 101,539 98,549 Four years later... 54,935 107,097 160,961 167,935 129,958 102,626 Five years later... 55,298 109,262 160,481 169,143 131,109 Six years later.... 55,914 108,652 160,736 170,077 Seven years later.. 56,084 108,635 161,117 Eight years later.. 56,278 108,645 Nine years later... 56,562 Net cumulative (deficiency) redundancy.........$ (26,288) $ (45,907) $ (35,769) $ (25,647) $ (11,146) $ (2,941) $ 43 $ (2,006) $ (3,808) $ - Supplemental Gross Data: Gross liability after reclassification of Pools - end of year..........................................$ 225,610 $ 179,815 $ 156,060 $ 128,794 $ 79,639 $ 74,929 Reclassification of Pool liabilities (1)....................... (18,875) (15,694) - - - - Gross liability before reclassification of Pools - end of year (1)......................................$ 206,735 $ 164,121 $ 156,060 $ 128,794 $ 79,639 $ 74,929 Reinsurance recoverable........................................ 86,772 64,436 57,468 46,777 14,432 10,876 Net liability - end of year (1)................................$ 119,963 $ 99,685 $ 98,592 $ 82,017 $ 65,207 $ 64,053 Gross re-estimated liability - latest (1)......................$ 209,652 $ 161,657 $ 154,404 $ 130,527 $ 86,292 Re-estimated recoverable - latest.............................. 78,543 59,031 55,855 46,504 17,277 Net re-estimated liability - latest (1)........................$ 131,109 $ 102,626 $ 98,549 $ 84,023 $ 69,015 Gross cumulative (deficiency) redundancy.......................$ (2,917) $ 2,464 $ 1,656 $ (1,733) $ (6,653) - ----------------------------------------------------------------- (1) The December 31, 1993 and prior amounts do not include the reclassification of Pool liabilities. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS".
PAGE 8 TRUST ARRANGEMENTS AND SPECIAL DEPOSITS Under the reinsurance arrangements with NAICO, Chandler Barbados has entered into a trust arrangement and established a trust account in favor of NAICO into which investments are deposited. The amount required in the trust account is adjusted periodically to secure reserves for unpaid claims, unearned premiums, reserves for unpaid allocated loss adjustment expenses and reserves for incurred but not reported claims after giving effect for any reinsurance premiums receivable from NAICO. NAICO requires substantially the same trust arrangements or irrevocable letters of credit from all of its non-admitted reinsurers. This not only provides security to NAICO concerning such reinsurance obligations but also enables NAICO to take credit on its statutory financial statements for such reinsurance pursuant to state laws and regulations. NAICO is required to deposit securities with regulatory agencies in several states in which it is licensed as a condition of conducting operations in the state. NAICO has also deposited funds pursuant to a trust arrangement securing reinsurance obligations it has assumed from an unrelated primary carrier. For additional information see Notes to Consolidated Financial Statements. INVESTMENTS Funds available for investment include the Company's present capital as well as premiums received and retained under insurance policies and reinsurance agreements issued by its subsidiaries. Until these funds are required to be used for the settlement of claims and the payment of operating expenses of the Company's subsidiaries, they are invested with the objective of generating income, preserving principal and maintaining liquidity. Fixed-maturity investments are purchased to support the investment strategies of the Company and its subsidiaries, which are developed based on many factors including rate of return, maturity, credit risk, tax considerations, regulatory requirements and their mix of business. At the time of purchase, investments in debt securities that the Company has the positive intent and ability to hold to maturity are classified as held to maturity and reported at amortized cost; all other debt securities are reported at fair value. Investments classified as trading are actively and frequently bought and sold with the objective of generating income on short-term differences in price. Realized and unrealized gains and losses on securities classified as trading account assets are recognized in current operations. The Company has not classified any investments as trading account assets. Securities not classified as held to maturity or trading are classified as available for sale, with the related unrealized gains and losses excluded from earnings and reported net of tax as a separate component of shareholders' equity until realized. Realized gains and losses on sales of securities are based on the specific certificate identification method and included in net investment income in the accompanying consolidated statements of operations. As of December 31, 1997 all of the investments of Chandler Barbados and of NAICO were in fixed-maturity investments (rated Aa3 or AA- or better by Moody's Investors Service, Inc. or Standard & Poor's, respectively), certificates of deposit (insured by the Federal Deposit Insurance Corporation), interest- bearing money market accounts, a collateralized repurchase agreement and common stock received in connection with an unaffiliated entity's conversion to a for- profit corporation. Madison Scottsdale, L.C. is responsible for managing $15.9 million of Chandler Barbados' portfolio at December 31, 1997. The remainder is managed by the Investment Committee of the Company's Board of Directors. Approximately $85.0 million of NAICO's investment portfolio at December 31, 1997 is managed by Madison Scottsdale, L.C. The remainder is managed by the Investment Committee of its Board of Directors. For additional information, see "Trust Arrangements and Special Deposits" and Notes to Consolidated Financial Statements. During 1997, NAICO received 19,371 shares of class B common stock of the Insurance Services Office, Inc. ("ISO") in connection with ISO's conversion to a for-profit corporation. ISO has placed certain limitations on the transfer or sale of the class B common stock one of which restricts ownership of the shares to insurance companies whose primary activity is the writing of insurance or the reinsuring of risk underwritten by insurance companies. EMPLOYEES AND ADMINISTRATION The Company and Chandler Barbados have no employees. Day-to-day management of the Company's operations and administrative affairs is performed in the Cayman Islands by Chandler Insurance Management, Ltd. ("CIM"), a wholly owned subsidiary of the Company. Day-to-day management of Chandler Barbados' operations and administrative affairs is performed in Barbados by Chandler Insurance Management (Barbados), Ltd. ("CIM Barbados"), a wholly owned subsidiary of the Company. Steven R. Butler, the Vice President-Administration of the Company and the President of Chandler Barbados, is the Financial Director of CIM and the Treasurer and a director of CIM Barbados. At December 31, 1997, the subsidiaries of the Company organized under the laws of the United States had approximately 332 full-time employees. The subsidiaries have generally enjoyed good relations with their employees. PAGE 9 REGULATION REGULATION IN GENERAL The Company's insurance subsidiaries are subject to regulation by government agencies in the jurisdictions in which they do business. The nature and extent of such regulation vary from jurisdiction to jurisdiction, but typically involve prior approval of the acquisition of control of an insurance company or of any company controlling an insurance company, regulation of certain transactions entered into by an insurance company with any of its affiliates, approval of premium rates, forms and policies used for many lines of insurance, standards of solvency and minimum amounts of capital and surplus which must be maintained, establishment of reserves required to be maintained for unearned premiums, losses and loss adjustment expenses or for other purposes, limitations on types and amounts of investments, restrictions on the size of risks which may be insured by a single company, licensing of insurers and agents, deposits of securities for the benefit of policyholders, and the filing of periodic reports with respect to financial condition and other matters. In addition, regulatory examiners perform periodic examinations of insurance companies. Such regulation is generally intended for the protection of policyholders rather than security holders. In addition to the regulatory oversight of the Company's insurance subsidiaries, the Company is also subject to regulation under the laws of the Cayman Islands and the Nebraska Insurance Holding Company System Act (the "Holding Company Act"). The Holding Company Act contains certain reporting requirements including those requiring the Company, as the ultimate parent company, to file information relating to its capital structure, ownership, and financial condition and general business operations of its insurance subsidiaries. The Holding Company Act contains special reporting and prior approval requirements with respect to transactions among affiliates. Insurance companies are also affected by a variety of state and federal legislative and regulatory measures and judicial decisions that define and extend the risks and benefits for which insurance is sought and provided. These include redefinitions of risk exposure in areas such as product liability, environmental damage and workers compensation. In addition, individual state insurance departments may prevent premium rates for some classes of insureds from reflecting the level of risk assumed by the insurer for those classes. Such developments may adversely affect the profitability of various lines of insurance. In some cases, these adverse effects on profitability can be minimized through re-pricing, if permitted by applicable regulations, of coverages or limitations or cessation of the affected business. The Company and NAICO Indemnity hold Unrestricted Class "B" Insurer's Licenses under provisions of the Insurance Law (1995 Revision) as amended of the Cayman Islands (the "Cayman Insurance Law"). An insurance company that is issued a Class "B" Insurer's License in the Cayman Islands is limited to writing insurance risks in jurisdictions other than the Cayman Islands. The Company, NAICO Indemnity and CIM are regulated by The Monetary Authority in the Cayman Islands and must comply with the Cayman Insurance Law. The Monetary Authority has broad discretionary powers to regulate the operations of insurance companies in the Cayman Islands, including among other things the approval of shareholders that may own shares in such companies and the establishment of insurance ratio guidelines such as the ratio of net premium income to shareholders' equity. Such regulation is generally less restrictive than that of state insurance regulatory agencies in the United States. The Cayman Insurance Law requires a licensed insurer to provide annual audited financial statements. The Company, NAICO Indemnity and CIM prepare their financial statements in accordance with U.S. GAAP. The Monetary Authority is charged with the responsibility of ensuring that licensed insurers comply with the provisions of the law, are in a sound financial position and are carrying on business in a satisfactory manner. The Cayman Islands currently does not have restrictions or exchange controls applicable to the Company or NAICO Indemnity concerning the transfer of any funds into or out of the Cayman Islands. Under the Cayman Insurance Law, any change in the information supplied on the application for the license must receive the prior approval of The Monetary Authority. Therefore, licensed insurers must generally obtain prior approval of The Monetary Authority of changes in their shareholders or their shareholdings. The Company has, however, obtained an exemption from such approval for shareholders owning 5% or less of the issued common shares of the Company. CIM obtained prior approval from The Monetary Authority before acquiring common shares of the Company. Chandler Barbados is licensed as an "exempt insurance company" by the Barbados Minister of Finance pursuant to the Barbados Exempt Insurance Act, Chapter 308A. That statute requires the maintenance of a minimum level of capital, payment of applicable license fees, annual preparation and filing of audited financial statements, and establishes standards of solvency that must be maintained. Exempt insurance companies are exempted from the provisions of the Barbados Exchange Control Act. Chandler Barbados and CIM Barbados are subject to regulation by the Supervisor of Insurance in Barbados. The activities of L&W related to insurance brokerage and agency services and claims administration services are subject to licensing and regulation by the jurisdictions in which it conducts such activities. In addition, most jurisdictions require that certain individuals engaging in brokerage and agency activities be personally licensed. As a result, a number of L&W's employees are so licensed. PAGE 10 INSURANCE REGULATION CONCERNING CHANGE OR ACQUISITION OF CONTROL NAICO is a domestic property and casualty insurance company organized under the insurance laws of Nebraska (the "Insurance Code"). The Insurance Code provides that the acquisition or change of "control" of a domestic insurer or of any person that controls a domestic insurer cannot be consummated without the prior approval of the relevant insurance regulatory authority. A person seeking to acquire control, directly or indirectly, of a domestic insurance company or of any person controlling a domestic insurance company must generally file with the relevant insurance regulatory authority an application for change of control containing certain information required by statute and published regulations and provide a copy of such to the domestic insurer. In Nebraska, control is generally presumed to exist if any person, directly or indirectly, owns, controls, holds with the power to vote or holds proxies representing 10% or more of the voting securities of the insurance company or of any other person or entity controlling the insurance company. The 10% presumption is not conclusive and control may be found to exist at less than 10%. In addition, many state insurance regulatory laws contain provisions that require pre-notification to state agencies of a change in control of a non- domestic admitted insurance company in that state. While such pre-notification statutes do not authorize the state agency to disapprove the change of control, such statutes do authorize issuance of a cease and desist order with respect to the non-domestic admitted insurer if certain conditions exist such as undue market concentration. Any future transactions that would constitute a change in control of the Company would also generally require prior approval by the Insurance Department of Nebraska and would require pre-acquisition notification in those states which have adopted pre-acquisition notification provisions and in which the insurers are admitted. Since such requirements are primarily for the benefit of policyholders, they may deter, delay or prevent certain transactions that could be advantageous to the stockholders of the Company. RESTRICTIONS ON DIVIDENDS A significant portion of the Company's consolidated assets represents assets of the Company's insurance subsidiaries that may not be transferable to the holding company in the form of dividends, loans or advances. The Company's insurance subsidiaries are subject to various state statutory and regulatory restrictions, generally applicable to each insurance company in its state of incorporation, which limit the amount of dividends or distributions by an insurance company to its stockholders. The restrictions are generally based on certain levels of surplus, operating income and investment income, as determined under statutory accounting practices. The Holding Company Act regulates the distribution of dividends and other payments to the Company by its subsidiaries. Under the applicable Nebraska statute, the maximum discretionary dividend that may be declared (or cash/property distribution that may be made) by NAICO is the greater of (i) the insurance company's net income (excluding realized capital gains) for the preceding calendar year plus net income (excluding realized capital gains) from the second and third preceding calendar years (that was not paid in dividends or other distributions) or (ii) ten percent of the insurance company's policyholders' surplus for the preceding calendar year, excluding unrealized gains. These dividends are further limited by a clause in the Nebraska law which prohibits an insurer from declaring dividends except out of earned surplus of the company, as allowed under the Insurance Code. The payment of cash dividends by Chandler Barbados is limited to its realized earned surplus and margin of solvency requirements. Chandler Barbados and NAICO (during ownership by the Company) have not paid any cash shareholder dividends. See Notes to Consolidated Financial Statements. RISK-BASED CAPITAL The National Association of Insurance Commissioners has adopted a methodology for assessing the adequacy of statutory surplus of domestic property and casualty insurers which includes a risk-based capital requirement that requires insurance companies to calculate and report information under a risk-based formula which attempts to measure statutory capital and surplus needs based on the risks in a company's mix of products and investment portfolio. The formula is designed to allow state insurance regulators to identify potential under-capitalized companies. Under the formula, a company determines its "risk-based capital" ("RBC") by taking into account certain risks related to the insurer's assets (including risks related to its investment portfolio and ceded reinsurance) and the insurer's liabilities (including underwriting risks related to the nature and experience of its insurance business). The risk-based capital rules provide for different levels of regulatory attention depending on the ratio of a company's total adjusted capital to its "authorized control level" ("ACL") of RBC. At December 31, 1997, NAICO's statutory surplus was $45.3 million; the threshold requiring regulatory involvement was $7.7 million. Therefore, NAICO's capital exceeds the level that would trigger regulatory attention pursuant to the Risk-Based Capital Model Act. PAGE 11 NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS-IRIS RATIOS The National Association of Insurance Commissioners Insurance Regulatory Information System ("IRIS") was developed by a committee of state insurance regulators and is primarily intended to assist state insurance departments in executing their statutory mandates to oversee the financial condition of insurance companies operating in their respective states. IRIS identifies 11 industry ratios and specifies "usual values" for each ratio. Departure from the usual values on four or more ratios generally leads to inquiries from individual state insurance commissioners. In 1997, NAICO had no ratios which varied from the "usual value" ranges. EFFECT OF FEDERAL LEGISLATION Although the federal government does not directly regulate the business of insurance, federal initiatives often affect the insurance business in a variety of ways. Current and proposed federal measures which may significantly affect the insurance business include federal government participation in asbestos and other product liability claims, pension and other employee benefit plan regulation (ERISA), examination of the taxation of insurers and reinsurers, minimum levels of liability insurance and automobile safety regulations. Federal regulation of the health care industry may directly and indirectly impact the business of insurance. TAXATION The following summary of certain United States and foreign taxes is based upon the Company's understanding of applicable tax law. The tax treatment of an investment in the Company's common shares may vary depending upon a shareholder's individual circumstances. Certain shareholders, such as foreign corporations, may be subject to special rules not discussed below. FOREIGN TAXES. The Company, Chandler Barbados and NAICO Indemnity are not obligated to pay any income or capital gains taxes in the Cayman Islands or Barbados. The Company is required to pay an annual fee based on its authorized capital, plus an annual license fee. Chandler Barbados is required to pay an annual license fee. The Company, NAICO Indemnity and Chandler Barbados have received tax concession guarantees from the Cayman Islands or Barbados, as applicable, for all taxes levied upon profits, income, gains and appreciation that are valid through September 30, 2003, March 10, 2012 and May 19, 2003, respectively. UNITED STATES EXCISE TAXES. Foreign insurance and reinsurance companies such as NAICO Indemnity and Chandler Barbados are subject to a 1% United States excise tax on reinsurance premiums received with respect to reinsured risks located in the United States and a 4% United States excise tax on direct premiums written and received with respect to insured risks located in the United States. UNITED STATES TAXATION OF SHAREHOLDERS. Under Section 951(b) of the Internal Revenue Code of 1986 as amended (the "Code"), any United States corporation, citizen, resident or other United States person who owns, directly or indirectly, or is considered to own (by application of the rules of constructive ownership set forth in Code Section 958(b), generally applying to family members, partnerships, estates, trusts or controlled corporations) 10% or more of the total combined voting power of all classes of voting stock of the Company will be considered a "United States shareholder" for United States income tax purposes. If such "United States shareholders" collectively own more than 25% of the value or combined voting power of all classes of the Company's stock for an uninterrupted period of 30 days or more during any taxable year, each "United States shareholder" will be required to include in his gross income his share of the Company's "subpart F insurance income," whether or not this income is distributed to him. The Company's "subpart F insurance income" would include, among other items, income derived from the reinsurance of risks located outside the Company's country of incorporation. In addition, if such "United States shareholders" collectively own more than 50% of the Company's stock for an uninterrupted period of 30 days or more during any taxable year, each "United States shareholder" will be required to include in gross income the Company's "other subpart F income" and amounts under Section 956, whether or not such income and amounts are distributed to him. The Company's Section 956 amounts would include certain amounts invested by the Company in U.S. property. The Company's "other subpart F income" would include most interest and other investment income and gains. See "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - Possible Change in Control". Currently, M. J. Moroun, individually and through CenTra, Inc. ("CenTra") and their affiliates (the "Moroun Group"), beneficially owns roughly 45% of the outstanding voting stock of the Company. See "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - Other Matters Regarding Beneficial Ownership". The Company is not aware of any other U.S. shareholders who currently own (directly or indirectly) 10% or more of the Company's stock. Assuming that the Moroun Group is considered to own the value and voting power of shares that it owns directly or indirectly, notwithstanding certain temporary restraints on its right to vote such stock, the Company will be treated as a controlled foreign corporation ("CFC"), at least with respect to its "subpart F insurance income", and possibly with respect to its "other subpart F income" and Section 956 amounts, and the Moroun Group and any other "United States shareholders" may be subject to tax on the Company's "subpart F insurance income" and possibly also its "other subpart F income" and Section 956 amounts, in 1992 and subsequent periods. PAGE 12 Under Section 953(c) of the Code, if U.S. persons indirectly own (i.e., through ownership of the Company) 25% or more of the total combined voting power of all classes of Chandler Barbados' stock entitled to vote or 25% or more of the total value of Chandler Barbados' stock, then each such person is required to include in his gross income a portion of any insurance income of Chandler Barbados attributable to a policy of insurance or reinsurance with respect to which the person insured (directly or indirectly) is a related person to a shareholder in Chandler Barbados ("related person insurance income" or "RPII"). Under these rules, all U.S. persons who own stock in the Company (including Chandler's U.S. subsidiaries) would generally be required, subject to the exception discussed hereinafter, to include in their gross incomes a portion of the RPII received by Chandler Barbados from NAICO. However, related person insurance income of Chandler Barbados need not be included in the income of a U.S. person who is not a "United States shareholder," as defined above, if, at all times during Chandler Barbados' taxable year, less than 20% of the total combined voting power of all classes of stock of Chandler Barbados and less than 20% of the total value of Chandler Barbados is owned (directly or indirectly) by persons who are (directly or indirectly) insured under any policy of insurance or reinsurance issued by Chandler Barbados, or who are related persons to any such person. In connection with its examination of the 1992 federal income tax return of the Company's wholly owned subsidiary Chandler (U.S.A.), Inc. ("Chandler USA"), the Internal Revenue Service (the "IRS") contended that Chandler Barbados did not qualify, for its 1992 and subsequent taxable years, for the exception to the inclusion of RPII for all U.S. persons who hold the Company's stock, because the Company owns more than 20% of the voting power and value of Chandler Barbados, and the Company is a related party to NAICO, which purchases reinsurance from Chandler Barbados. However, Chandler USA believed, and asserted to the IRS that U.S. persons who hold less than 5.5% of the stock of the Company should not be required to include any RPII of Chandler Barbados in their incomes. The IRS agreed with Chandler USA's position on this issue, and a formal closing agreement was executed in 1996. Under Section 956A, which was repealed effective January 1, 1997, if the Company or any foreign subsidiary is a CFC, each "United States shareholder" (as defined previously) of the Company or such foreign subsidiary will be required to include in his gross income an amount determined with respect to the Company's or the foreign subsidiary's "excess passive assets" for the taxable year. Generally, any amount of "passive assets" in excess of 25% of the Company's or a foreign subsidiary's total assets will be considered "excess passive assets." "Passive assets" are assets that produce, or are held for the production of, passive income (e.g., dividends, interest, rents, and royalties). "Passive income" does not include income "derived in the active conduct of an insurance business by a corporation which is predominantly engaged in an insurance business and which would be subject to tax under Subchapter L (relating to insurance companies) if it were a domestic corporation." In addition, certain "look-through" rules treat a foreign corporation that owns (directly or indirectly) at least 25% by value of the stock of another corporation as if the foreign corporation held its proportionate share of the assets of the other corporation and received directly its proportionate share of the income of the other corporation. Management believes that no amount is includible in the income of a "United States shareholder" under Section 956A. However, there can be no assurance that the IRS will not successfully challenge this position. Under Section 552 of the Code, the Company or any foreign subsidiary may be classified as a foreign personal holding company ("FPHC") if (i) at least 60% (or in the case of any corporation that has been classified as an FPHC in a previous year, 50%) of its gross income for the taxable year is FPHC income and (ii) at any time during the taxable year more than 50% of the total voting power or the total value of the stock of such company is owned (directly or indirectly) by or for not more than five individuals who are citizens or residents of the United States. FPHC income generally includes interest, royalties, annuities, gains from the sale or exchange of stock or securities and dividends, other than the non-FPHC portion of dividends. For purposes of determining a person's stock ownership, stock owned by a corporation will be considered to be owned proportionately by its shareholders. Hence, each ultimate individual owner of the Company will be treated as owning a portion of the stock of the Company determined by looking through all intermediate ownership entities. If the Company or any foreign subsidiary is classified as an FPHC by application of the above-stated rules, then each U.S. person owning stock in the Company or such foreign subsidiary will be required to include in his gross income, as a dividend, for the taxable year an amount equal to his share of the undistributed FPHC income of such corporation. Although management has concluded that the Company and its foreign subsidiaries satisfy the 50% ownership test, none of the foreign subsidiaries satisfy the 60% gross income test, and the Company did not receive any material income for its taxable years ending in 1995, 1996 and 1997. Under Section 542 of the Code, the Company and each of its subsidiaries may be classified as a personal holding company ("PHC"). A corporation will be classified as a PHC if (i) it is not an FPHC or a passive foreign investment company ("PFIC"); (ii) at least 60% of its adjusted ordinary gross income (as defined in Section 543) for the taxable year is PHC income; (e.g., dividends, interest, annuities, royalties and rents) and (iii) at any time during the last half of the taxable year more than 50% in value of its outstanding stock is owned (directly or indirectly) by or for not more than five individuals. In the case of an affiliated group filing or required to file a consolidated U.S. income tax return, the 60% test is generally applied to the affiliated group as a whole and no members of the affiliated group will be considered to satisfy the 60% test unless the affiliated group meets the 60% test. If either the Company or any of its subsidiaries is classified as a PHC, such PHC will be subject to a PHC tax equal to 39.6% of the undistributed PHC income. Based on the proportion of the gross income of the Company and each of its subsidiaries that consisted of PHC income, the Company's management believes that neither the Company nor any of its subsidiaries constituted a PHC for its taxable years ending in 1995, 1996 and 1997. PAGE 13 UNITED STATES INCOME TAXATION OF THE COMPANY AND ITS SUBSIDIARIES. Chandler Barbados is organized and endeavors to conduct its business from Barbados and not within the United States. Accordingly, Chandler Barbados does not presently file United States income tax returns. Pursuant to United States Treasury Regulations, Chandler Barbados has filed, and will continue to file, protective returns for its taxable years ending after July 31, 1990 indicating that it is not engaged in business in the United States and that even if it is so engaged it does not conduct such business through a permanent establishment in the United States so that, under the U.S.-Barbados Income Tax Treaty it is not subject to United States Federal income tax on its insurance income. However, since neither the Code, court decisions nor regulations definitively describe activities that constitute being engaged in a trade or business in the United States, there can be no assurance that the IRS will not successfully contend that Chandler Barbados is engaged in a trade or business in the United States through a permanent establishment on the basis that the Company's affiliates or its shareholders, employees, officers or directors are agents of Chandler Barbados in the United States. If Chandler Barbados is deemed to be so engaged, it will be subject to United States income tax on its income that is effectively connected with the conduct of that trade or business. Such income tax, if imposed, would be computed on the effectively connected income in a manner comparable to the computation of income of a domestic insurance corporation, except that (i) Chandler Barbados may be subject to an additional "branch profits tax" on deemed dividend equivalents and interest payments, and (ii) Chandler Barbados' applicable deductions and credits will be disallowed if it fails to file a return for its taxable years ended prior to July 31, 1990 or to timely file the protective United States income tax return described above for taxable years ended after July 31, 1990. Chandler Barbados has not filed a return for the taxable years ended prior to July 31, 1990. Regardless of whether Chandler Barbados is considered to be engaged in a trade or business in the United States, it is subject to United States income tax on certain "fixed or determinable annual or periodic gains, profits and income" derived from sources within the United States as enumerated in Section 881(a) of the Code, including dividends and related party interest but generally excluding interest from unrelated parties. This tax is imposed on the gross amount of such income, generally at a fixed 30% rate but, in the case of dividends from Chandler USA to Chandler Barbados, at a 5% rate. The United States person responsible for payment of such items of income to Chandler Barbados is obligated to withhold this tax before payment is made to Chandler Barbados. NAICO is subject to tax on its taxable income under subchapter L of the Code. Reinsurance premiums paid by NAICO are generally deductible for this purpose. The IRS in Revenue Ruling 77-316 has taken the position that where a United States parent corporation and its domestic subsidiaries insure their risks with an offshore subsidiary, the premiums paid to the offshore corporation are not deductible by the United States corporation and, if paid by the United States subsidiaries, are constructive distributions to the United States parent. Certain court cases have supported the IRS's position that premiums paid by a parent to its subsidiary are not deductible. The IRS could argue that premiums paid to Chandler Barbados should not be deductible and that instead, to the extent of NAICO's earnings and profits, they should be characterized as dividends subject to a 5% withholding tax. The IRS has the authority under Section 482 of the Code to reallocate income, deductions and credits among related taxpayers. If the IRS were successfully to contend that a portion of the premiums paid by NAICO to Chandler Barbados exceeded an arm's length premium, such excess amount would probably be characterized as a distribution by Chandler USA to Chandler Barbados with the result that the United States consolidated group would not be permitted a deduction, and Chandler Barbados would be subject to a 5% withholding tax with respect to such excess amount. Any determination that Chandler Barbados was engaged in business in the United States, any disallowance of deductions for most or all of the reinsurance premiums paid by NAICO to Chandler Barbados or any substantial reallocation of income from Chandler Barbados to NAICO would cause substantially all of the Company's consolidated net income before income taxes to be subject to United States income tax with credit given for income and excise taxes previously paid. Between January 1, 1987 and March 31, 1988, the Company performed the reinsurance functions currently performed by Chandler Barbados. The above description of the potential United States income taxation of Chandler Barbados is equally applicable to the activities of the Company during that period, except that any U.S. withholding tax requirements would be at a rate of 30% rather than a 5% rate. On October 25, 1994 the IRS proposed increases in federal income tax and the imposition of federal withholding tax and penalties payable by Chandler USA for calendar years 1989 through 1992 in the approximate amount of $2.5 million plus interest. With the exception of the increase in Chandler USA's income for a proposed amount of subpart F income (see "United States Taxation of Shareholders") the remaining proposed increase in income tax arose from the disallowance of deductions for certain expenses (primarily litigation costs - see "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS") incurred by Chandler USA in calendar years 1991 and 1992, and the subsequent disallowance of a net operating loss carryback to calendar years 1989 through 1991. The proposed withholding tax assessment arose out of an assertion by the IRS that certain of the non-deductible expenses were incurred for the benefit of the Company, that they should be treated as a deemed distribution by Chandler USA to the Company, and as such should be subject to a 30% U.S. withholding tax. Chandler USA disagreed with the proposed adjustments and filed a written protest of the proposed adjustments on December 23, 1994. During the fourth quarter of 1995, after numerous discussions and preliminary consensus with the IRS, Chandler USA made a provision for possible assessments of additional taxes through 1992 and additional taxes attributable to amended returns for 1993 and 1994 in the amount of $536,000. During 1996, the IRS and Chandler USA executed a formal closing agreement, Chandler USA paid the taxes for the open tax years (1989 through 1994) and the IRS closed its examination. PAGE 14 During 1996, the IRS conducted a field examination of the U.S. Federal income tax returns of Chandler USA and its wholly owned subsidiaries for the years 1993 and 1994. The IRS completed the examination in the fourth quarter of 1996 and there were no proposed adjustments to tax liabilities. ITEM 2. PROPERTIES The Company's principal office is located on the 5th Floor, Anderson Square in Grand Cayman, Cayman Islands, B.W.I. Chandler Barbados' principal office is located in the Stevmar House, Rockley, Christ Church, Barbados. The Company and Chandler Barbados have no offices in the United States. The Company's United States-based subsidiaries own and occupy three office buildings with approximately 81,000 square feet of usable space at the home office in Chandler, Oklahoma. The Company's subsidiaries also lease approximately 10,600 square feet in the aggregate for its branch offices. The Company believes such space will suffice for the foreseeable future. ITEM 3. LEGAL PROCEEDINGS CENTRA LITIGATION -- GENERAL BACKGROUND CenTra is a Detroit-based holding company primarily engaged in the trucking industry. Beginning in 1987, NAICO insured CenTra's automobile liability, general liability and workers compensation risks through reinsurance arrangements involving DuraRock Underwriters, Ltd. ("DuraRock"), a Barbados company and an affiliate of CenTra, its predecessor Can-Am Underwriters, Ltd. ("Can-Am") and Chandler Barbados. In addition to the insurance arrangements, CenTra and its affiliates have been significant shareholders in the Company (holding approximately 22.7% of the Company's common stock at July 1, 1992). See "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT". Three present or former executive officers of CenTra, Norman E. Harned, Ronald W. Lech and M. J. Moroun, are directors of the Company. See "DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT". Beginning in 1992, the relationships between the Company and CenTra deteriorated largely due to differences about the CenTra insurance program, CenTra's failure to make timely premium payments and CenTra's role in an anticipated management-led tender offer. In an apparent attempt to block the tender offer and seize control of the Company, CenTra began, on July 1, 1992, a series of common stock purchases and offers to purchase that would, over the following two weeks, place almost one-half of the Company's common stock with CenTra and its affiliates. On July 1 and 2, 1992, CenTra made an offer to Chandler USA, an indirect subsidiary of the Company, to purchase 1,117,679 common shares. These common shares were either owned by Chandler USA (567,350 common shares) or pledged to a subsidiary and owned by Cactus Southwest Corp. (169,858 common shares) or the Universal Insurance Group (380,471 common shares). Chandler USA declined the offer. On July 2, 1992, NAICO and NAICO Indemnity canceled the CenTra insurance policies for non-payment of premiums effective September 5, 1992. On July 2, 1992, CenTra made an offer to Cactus Southwest Corp. to purchase 169,858 common shares owned by it but pledged to the Chandler USA subsidiary to collateralize certain receivables. On July 7, 1992, the Nebraska Department of Insurance (the "Department") ordered CenTra to cease and desist purchases of the Company's common shares. On July 9, 1992, M.J. Moroun withdrew CenTra's prior offer to Cactus Southwest Corp. and offered to purchase the same common shares himself. At the same time, he began purchasing common shares in the open market. On July 10, 1992, the Department ordered CenTra and its affiliates and Messrs. M.J. Moroun, Harned and Lech to cease and desist purchases of the Company's common shares. On the same date, M.J. Moroun made an offer to the Universal Insurance Group to purchase 380,471 common shares owned by it but pledged to the Chandler USA subsidiary, and M.J. Moroun made further open market purchases. On July 11, 1992, M.J. Moroun paid $100,000 to the Universal Insurance Group for an irrevocable proxy and contracted with it for the purchase of its pledged common shares. On July 12, 1992, M.J. Moroun contracted with Cactus Southwest Corp. for the purchase of its pledged common shares. On July 13, 1992, further open market purchases were made in the name of Can-Am, a not-yet-formed Bahamian affiliate of CenTra. Also on July 13, 1992, the District Court for Lancaster County, Nebraska entered a temporary restraining order against CenTra, Messrs. M.J. Moroun, Harned and Lech, John and Jane Doe, XYZ Corporation, and their affiliates known and unknown, prohibiting further purchases. On July 14 and 17, 1992, the stock brokerage firm through which the open market purchases were made purportedly substituted Can-Am for M.J. Moroun as the purchaser on the July 9 and 10 sales confirmations. At some time after July 13, 1992, M.J. Moroun assigned his rights to purchase the pledged shares of the Universal Insurance Group and Cactus Southwest Corp. to Can-Am; neither CenTra nor Can-Am now claim ownership or any interest in the shares. During the second quarter of 1997, ownership of 380,471 shares was transferred to a Chandler subsidiary as payment for one of the agent's debts. In December 1997, 114,146 shares were transferred to a Chandler subsidiary and the balance of the pledged shares were transferred to unaffiliated persons and entities. These transactions had the effect of canceling the debts secured by the shares. The shares are held as a reduction of shareholders' equity. Through the above transactions, CenTra and its affiliates acquired, or contracted to acquire, an additional 26.5% of the Company's common stock, bringing their total claimed stock ownership to 49.2% in July 1992. The tender offer, which commenced on July 9, 1992 without knowledge of the open market purchases, was withdrawn on July 23, 1992. See "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT" for further information about the stock ownership of CenTra and its affiliates. As these developments unfolded, CenTra or its affiliates or both initiated litigation in Oklahoma, Arkansas and Michigan, and an administrative proceeding in Nebraska, the domicile of NAICO. PAGE 15 CENTRA LITIGATION -- OKLAHOMA BACKGROUND OF OKLAHOMA LAWSUIT. On July 16, 1992, CenTra and Messrs. M.J. Moroun, Lech and Harned filed a lawsuit in the United States District Court for the Western District of Oklahoma against the Company, the other corporations participating in the tender offer, and various individuals including certain officers and employees of the Company and its subsidiaries and the remaining directors of the Company, except Mr. Paul Maestri. The lawsuit sought declaratory and injunctive relief to prevent the tender offer alleging breaches of fiduciary and other duties and violations of the federal securities laws. After the tender offer was withdrawn, the plaintiffs amended their complaint on August 5, 1992, alleging breaches of fiduciary and other duties by commencing the tender offer and violations of federal securities laws in the tender offer and in certain transactions since 1988. The Company and the other defendants denied any breaches of duty or violations of law and the Company filed various counterclaims against CenTra and various affiliates alleging breaches of fiduciary duties and violations of federal securities laws in their attempts to seize control of the Company through the July 1992 stock purchases, and sought damages, costs and attorney fees. The Company also asserted a counterclaim against M.J. Moroun, individually, based upon his alleged violation of Section 16(b) of the Securities Exchange Act of 1934 regarding "short swing" profits. On January 6, 1993, the plaintiffs filed a second amended complaint (i) asserting violations of federal securities laws and a breach of contract claim in a 1988 stock purchase; (ii) asking the court to declare invalid and unenforceable a corporate resolution based on Article XI of the Company's Articles of Association (prohibiting certain business combinations) that prohibits Can-Am and its affiliates (including CenTra) from voting their shares of the Company's common stock; and (iii) asserting 13 derivative claims for fiduciary misconduct, unjust enrichment, fraud and/or breach of contract in the tender offer, for management bonuses in 1988 and 1989, in the Company's purchase of three management-related agencies in 1988, and for assorted improper personal benefits. All of these derivative claims seek unspecified damages, restitution and/or injunctive relief on behalf of the Company, including punitive damages, attorneys' fees and costs. In 1994 the plaintiffs made a request to file a third amended complaint. The Court denied that request. A three member committee ("Special Committee"), who are on the board of directors of NAICO and are not named in the lawsuits, investigated the derivative claims. The Special Committee concluded the Company should take no action against the individual defendants regarding the claims relating to the tender offer, the management bonuses and the agency purchases. As to the allegedly improper personal benefits, the Special Committee found that some were ordinary and necessary business expenses while others were not. The Special Committee recommended that the recipients reimburse the Company or the affected subsidiaries for all improper personal benefits, the full value of which was $135,000. The respective Boards of Directors of the Company and the affected subsidiaries accepted the report and recommendations of the Special Committee and retained special legal counsel to implement the recommendations of the Special Committee. Messrs. M.J. Moroun, Lech and Harned dissented. On July 20, 1992, CenTra sued NAICO in the Circuit Court of Macomb County, Michigan alleging that NAICO and certain officers and directors wrongfully canceled insurance policies issued to CenTra. CenTra claimed that the cancellation was retaliation for CenTra's decision not to participate in the tender offer, requested that the policies be reinstated, and sought monetary damages for the wrongful cancellation. The case was removed to the U.S. District Court for the Eastern District of Michigan. NAICO replied that the cancellation was proper based on CenTra's continuing failure to pay premiums. After two extensions of the cancellation date, the policies were canceled effective on September 5, 1992 after CenTra acquired replacement insurance. On August 26, 1992, CenTra deposited $700,000 with the court clerk under court order as security for premiums due under the NAICO policies. On October 13, 1992, the court granted defendants' motion to transfer the action to the U.S. District Court for the Western District of Oklahoma. On January 27, 1993, plaintiff filed an application in the Court of Appeals for the Sixth Circuit contending that the district court abused its discretion by transferring the case to Oklahoma. The application was denied. CenTra then filed a motion in the U.S. District Court in Oklahoma to transfer the case to Michigan. The U.S. District Court in Oklahoma retained jurisdiction of the case. NAICO filed a claim seeking payment of the unpaid premiums and contended that the cancellations were proper and denied that CenTra suffered any damages as a result of the cancellations, or any action taken by NAICO associated with the cancellations. OKLAHOMA JUDGMENTS - APRIL 22, 1997, MARCH 10, 1998. On February 13, 1997, trial commenced in the United States District Court in Oklahoma City, Oklahoma (the "Oklahoma Federal Court") in the consolidated cases involving CenTra and certain of its affiliates, officers and directors (the "CenTra Group") and the Company and certain of its affiliates, officers and directors. On April 1, 1997, at the close of all of the evidence, the Court entered judgment in favor of NAICO on CenTra's claims for alleged wrongful cancellation of CenTra's insurance with NAICO and the affiliate in 1992. See CenTra Litigation - Other. The remaining issues were submitted to a jury. On April 9, 1997, the jury returned verdicts on all claims. On April 22, 1997, the Oklahoma Federal Court entered judgments on all verdicts returned. One judgment against the Company requires the CenTra Group to return stock it purchased in 1990 to the Company in return for a payment of $5,099,133 from the Company. Another judgment was against both the Company and its affiliate Chandler Barbados and in favor of CenTra and its affiliate Ammex, Inc. Based upon an alleged breach of a stock purchase agreement in 1988, CenTra and Ammex were awarded $6,882,500. Both judgments related to alleged failures by the Company to adequately disclose the fact that ownership of the Company's stock may be subject to regulation by the Nebraska Insurance Department under certain circumstances. The jury also found in favor of CenTra and against certain officers and/or directors of the Company on the securities claims relating to CenTra's 1990 purchases and the failure to disclose the application of Nebraska insurance law, but awarded damages of $1 against each individual defendant on those claims. On PAGE 16 ten derivative claims brought by CenTra, the jury found in CenTra's favor on three. Certain officers were directed to repay to Chandler USA bonuses received for the years 1988 and 1989 totaling $711,629 and a total of $25,000 for personal use of corporate aircraft. On the remaining claim relating to the acquisition of certain insurance agencies in 1988, the jury awarded $1 each against six officers and/or directors. On other claims asserted by the CenTra Group, the jury found in favor of the Company and/or the individual defendants. The jury also found in favor of NAICO and NAICO Indemnity on their counterclaims for CenTra's failure to pay insurance premiums in the sum of $788,625 and further upheld a resolution adopted by the Chandler Board of Directors in August 1992 pursuant to Article XI of the Company's Articles of Association preventing CenTra and its affiliates from voting their Chandler stock as a result of purchases made by the CenTra Group in July 1992 as part of its efforts to acquire control of Chandler. The jury found in favor of CenTra on the Company's claim against CenTra for breach of a standstill agreement contained in a 1988 stock exchange agreement. The jury denied the Company's claim against Messrs. Harned, Lech and Moroun based upon their alleged breach of fiduciary duty as directors. The jury also denied the Company's claim against Mr. Moroun individually for violation of Section 16(b) of the Securities Exchange Act of 1934 regarding short swing profits. Several post-trial motions were filed by all parties relating to the judgments and prejudgment interest. The Oklahoma Federal Court ordered that additional motions for costs and attorney fees be filed within 20 days following rulings on these motions. However, on October 11, 1997 CenTra filed motions for costs and attorneys fees totaling $4.7 million. The Company responded by contending that the motions were filed prematurely and are, in any event, without merit. As a result of the April 22, 1997 judgments, the Company recorded a net charge for the litigation matters described above during the first quarter of 1997 totaling approximately $8.3 million ($8.5 million including provision for federal income tax). In addition, the Company recorded the return of 517,500 shares of the Company's stock in conjunction with the stock rescission judgment as a decrease to shareholders' equity in the amount of approximately $4.9 million with the remaining amount included in the charge for litigation matters. The charge includes approximately $4.6 million as an estimate of interest, costs and related attorney fees. The charge includes an estimated recovery of $2.7 million from the Company's directors and officers policy insurer for costs associated with the defense and litigation of these matters. The Company is entitled to a total of $5 million under the applicable insurance policy. Some amounts have been previously paid without dispute and the Company is negotiating with the insurer for payment of the policy balance. The Company could recover the remaining policy limits or could compromise its claim, and could incur significant costs in either case. The estimated insurance recovery is based upon these variable factors. The charge also includes the amount of judgments in favor of Chandler USA on the derivative claims discussed above. Except for the recovery of a portion of the litigation costs from the Company's directors and officers policy insurer, no provision has been made in the accompanying consolidated financial statements related to the advancement of litigation expenses to certain defendants. See "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Advancement of Litigation Expenses". On March 10, 1998, the Oklahoma Federal Court disposed of all post-trial motions filed by the parties. The parties had asked the Oklahoma Federal Court to vacate or modify judgments unfavorable to them and requested the Oklahoma Federal Court to award prejudgment interest. The Oklahoma Federal Court overruled all pending motions except a motion by the Company and Chandler Barbados to require CenTra and its affiliates to deliver 1,142,625 Shares of Chandler common stock they own or control upon payment of the $6,882,500 judgment which was entered in CenTra's favor in April 1997. The Company has recorded the return of 1,142,625 shares of the Company's stock in conjunction with the order as a decrease to shareholders' equity as of December 31, 1997, and reduced the previous first quarter of 1997 net charge for litigation matters by $6,882,500. The CenTra parties were directed to deliver the shares upon payment of the judgment. CenTra's pending motion for an award of costs and attorney fees was stricken and all parties were granted leave to file such motions within 20 days of March 10, 1998. On March 16, 1998 CenTra and its affiliates filed such motions seeking an award of costs and attorney fees totaling approximately $4.7 million. All parties may appeal any or all of the orders of the Oklahoma Federal Court. On March 23, 1998, CenTra and its affiliates filed a formal notice of intent to appeal certain orders of the Oklahoma Federal Court but have not yet stated specifically the claims or issues they or any of them will appeal. Because all shares of the Company's stock owned by CenTra and its affiliates are held by the U.S. District Court for the District of Nebraska ("Nebraska Court") it is unclear when or if CenTra and its affiliates will be able to comply with the Oklahoma Federal Court's order. The Company believes that it is not required to pay the judgments until CenTra and its affiliates can deliver the shares to the Company. See "CenTra Litigation - Nebraska". The ultimate actual amounts resulting from potential motions for the award of costs and attorney fees plus matters related to potential appeals by the parties could result in amounts significantly different from the Company's estimates, and could have a material adverse effect on the Company and could negatively impact future earnings. On April 28, 1997, the Company's Board of Directors appointed a Committee of the Board (the "Committee") to deal with all matters arising from the Oklahoma litigation. The Committee was delegated all authority of the Board on these issues. The members of the Committee are Messrs. Jacoby, Maestri and Davis, all of whom are non-parties to the CenTra litigation. The Committee has retained independent counsel. The individual members of the Committee review issues relating to litigation strategy, officer and director indemnification, and claims made under the Company's director and officer liability insurance policy on a regular basis in conjunction with a similar committee composed of Chandler USA directors. The Committee conducts its meetings outside the United States, but participates in telephone briefings and discussions at least twice monthly. PAGE 17 All implications of the Oklahoma Federal Court's ruling have not been fully evaluated by the Company. These issues are being studied by the Company's management and the Committee. In the event that the Company should decide to appeal, it may be required to post a supersedeas bond or bonds to suspend execution of any judgments against it. The Company believes that if it elects to pay the judgments, the shares owned by CenTra or its affiliates which are the subject of the judgment must be returned to the Company unless CenTra appeals and takes appropriate action to supercede the judgments, or the Nebraska Court does not release the shares. The Company's management believes that adequate financial resources are available to post a supersedeas bond or to pay the judgments. As a holding company, the Company may receive cash through equity sales, borrowings and dividends from its subsidiaries. Chandler Barbados and NAICO are subject to various regulations which restrict their ability to pay shareholder dividends. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Liquidity and Capital Resources". A reduction in the amount of invested assets, or an increase in borrowings resulting from potential payment of these judgments would reduce investment earnings or increase operating expenses in future periods. Chandler USA is the judgment creditor in connection with derivative claim judgments against certain Chandler officers and directors. Chandler USA's Special Litigation Committee is considering the course of action Chandler USA should take with regard to collection of those judgments. CENTRA LITIGATION -- NEBRASKA ADMINISTRATIVE. NAICO, which is domiciled in Nebraska, is regulated by the Nebraska Department of Insurance (the "Department"). The Department requires a Form A application and prior approval by the Department from anyone seeking to acquire control, directly or indirectly, of an insurance company regulated by the Department. CenTra, Can-Am and their affiliates filed a Form A application with the Department to which the Company and certain of its affiliates objected. See "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT". On October 28, 1992, the Department denied CenTra's Form A application. The Department found that (i) the financial condition of the CenTra Group might jeopardize the financial stability of NAICO or prejudice the interests of policyholders; (ii) the competence, experience and integrity of the CenTra Group is such that it would not be in the best interests of policyholders or NAICO or the public for the CenTra Group to control NAICO; and (iii) the acquisition is likely to be hazardous or prejudicial to the public. The CenTra Group appealed the Department's order to the Lancaster County District Court for the State of Nebraska ("District Court"). The District Court affirmed the Department's order on September 21, 1993. On December 1, 1995 the Nebraska Supreme Court affirmed the Department and the District Court decisions. On May 13, 1996 the U.S. Supreme Court denied the CenTra Group's Petition for Writ of Certiorari, thereby declining to review the decision of the Nebraska Supreme Court. NEBRASKA COURT ACTION. On October 6, 1995 Agnes Anne Moroun, sister of M.J. Moroun, purported to acquire 1,441,000 shares of the voting stock of the Company (the "Shares") from Can-Am Investments, Ltd., an affiliate of three of the Company's directors, M.J. Moroun, Norman E. Harned, and Ronald W. Lech. In response to that action, NAICO filed an action on October 11, 1995 in the District Court seeking an order sequestering the Shares based upon alleged violations of the Nebraska Holding Company Systems Act and orders of the Nebraska Department of Insurance. NAICO also sought a temporary order enjoining further transfers of the Shares and an order requiring the custodian of the Shares, Dean Witter, to deliver them to the court. Agnes Anne Moroun, M.J. Moroun, Norman E. Harned, and others removed the action to the Nebraska Court on October 17, 1995. The Nebraska Department of Insurance intervened on that same date requesting relief substantially similar to that requested by NAICO. The Honorable Warren K. Urbom conducted a hearing on October 18, 1995 and on October 30, 1995 granted the relief requested by NAICO. On October 31, 1995 the order was amended and was extended to 700 shares held by Can-Am Investments, Ltd. and was extended to include the CenTra Group's claim to rights to acquire stock. Dean Witter was directed to cause share certificates to be issued and delivered to the Clerk of the Nebraska Court. On November 8, 1995 the share certificates were issued listing Can-Am Investments, Ltd. as the shareholder of 1,441,700 shares pursuant to the order of the Nebraska Court. On November 2, 1995, Agnes Anne Moroun and the other defendants filed responsive pleadings and counterclaims against NAICO and the Director of Insurance of the State of Nebraska ("Insurance Director"). The counterclaims sought declaratory relief confirming the validity of the purported October 6, 1995 transfer of the Shares and that the Insurance Director and the courts of the State of Nebraska are without authority to sequester the Shares. The counterclaims also seek a judgment determining that NAICO's current management controls the Company without the approval of the Insurance Director and incidental relief. The Nebraska Court ruled in favor of NAICO on the counterclaims. On March 25, 1997 the Nebraska Court, pursuant to the Nebraska Insurance Holding Company Systems Act, ordered CenTra and certain of its affiliates to divest all Chandler shares owned by them, regardless of when purchased. The CenTra defendants own or control 3,133,450 Chandler shares. All such shares are currently in the possession of the Nebraska Court pursuant to the 1995 and 1997 orders of the Nebraska Court (including the shares subject to the Oklahoma Federal Court stock rescission judgments). CenTra's shares represent approximately 45.1% of the outstanding stock (including the shares subject to the Oklahoma Federal Court stock rescission judgments and the stock held by subsidiary). The Nebraska Court directed NAICO, the CenTra defendants and the Nebraska Insurance Department to submit proposals to the Nebraska Court by April 21, 1997 for the "orderly divestiture and disposition of the stock". A hearing would then be scheduled to consider the proposals. PAGE 18 CenTra has subsequently appealed the March 25, 1997 order of the Nebraska Court to the United States Court of Appeals for the Eighth Circuit where the appeal is now pending. Oral argument is currently scheduled for April 1998. CenTra's appeal of this order has resulted in a delay of the deadlines for submitting the proposals and no new submission date has been set at this time. On October 7, 1997 the Honorable Warren K. Urbom, U.S. District Judge for the Nebraska Court, ordered CenTra, M.J. Moroun and others to deliver into the registry of the Nebraska Court by November 6, 1997 all shares of Chandler stock owned or controlled by them or their affiliates not previously tendered, to await the outcome of the appeal of his divestiture order. CenTra requested a stay of that order. The stay was denied by Judge Urbom and CenTra was again ordered to deliver their shares to the Nebraska Court, this time by January 12, 1998. CenTra appealed that order to the U.S. Court of Appeals for the Eighth Circuit, which affirmed Judge Urbom's order. On February 9, 1998 CenTra deposited an additional 1,691,750 shares with the Nebraska Court. Because of the uncertainty of the outcome of CenTra's appeal of the Nebraska Court's orders, and until the final proposals are submitted and accepted, the Company is unable to predict the effect of the divestiture order on the rights, limitations or other regulation of ownership of the stock of any existing or prospective holders of the Company's common stock, or the effect on the market price of the Company's stock. The impact of the March 10, 1998 ruling of the Oklahoma Federal Court (See CenTra Litigation - Oklahoma) upon the divestiture order is currently unclear. On March 27, 1997 the Nebraska Court declined to exercise jurisdiction over 550,329 shares of Chandler stock held as security by Chandler subsidiaries for debts owed by two former agents but in which CenTra claimed to have option rights. The Nebraska Court's ruling cleared the way for the Company's subsidiaries to begin the process of disposing of these shares to retire the agents' debts to the subsidiaries. CenTra did not appeal this order. During the second quarter of 1997, ownership of 380,471 shares was transferred to a Chandler subsidiary as payment for one of the agent's debts. In December 1997, 114,146 shares were transferred to a Chandler subsidiary and the balance of the pledged shares were transferred to unaffiliated persons and entities. These transactions had the effect of canceling the debts secured by the shares. The shares are held as a reduction of shareholders' equity. CENTRA LITIGATION - OTHER On September 25, 1997, NAICO learned that several CenTra affiliates had filed two lawsuits in state court in Macomb County, Michigan against NAICO, NAICO Indemnity and certain NAICO officers asserting the same claims made and tried in the Oklahoma lawsuit described above (see CenTra Litigation - Oklahoma). Those claims were purportedly prosecuted by CenTra on its own behalf and on behalf of its subsidiaries. The Oklahoma Federal Court entered a judgment against CenTra on these claims. The damages sought are unspecified but the claims are based upon NAICO's cancellation of CenTra's insurance in 1992. NAICO and NAICO Indemnity contend that the Oklahoma Federal Court's adjudication is conclusive as to all claims. The lawsuits were removed to the U.S. District Court for the Eastern District of Michigan, Southern Division ("Michigan Federal Court"). NAICO and NAICO Indemnity have filed dispositive motions which are currently under advisement. On February 28, 1998 the Michigan Federal Court ordered the lawsuits transferred to the Oklahoma Federal Court. During the first quarter of 1997 the Company concluded an arbitration proceeding involving DuraRock and recorded approximately $315,000 in litigation and settlement expenses related to this matter. Since December 31, 1997, the Company has also resolved various issues resulting in settlement of litigation and arbitration proceedings among subsidiaries of the Company and CenTra affiliates, and has recorded litigation and settlement expenses of approximately $147,000 in 1997. At the present time the Company is actively participating in court proceedings, possible discovery actions and rights of appeal concerning these various legal proceedings; therefore, the Company is unable to predict the outcome of such litigation with certainty or the effect of such ongoing litigation on future operations. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" and Notes to Consolidated Financial Statements. OTHER LITIGATION The Company and its subsidiaries are not parties to any other material litigation other than as is routinely encountered in their respective business activities. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Due to the uncertainties created by the 1992 CenTra stock purchases and related regulatory uncertainties, it is uncertain whether a shareholders meeting will be held during 1998. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS MARKET The common shares of the Company trade on The NASDAQ Stock Market under the symbol: CHANF. PAGE 19 The following table sets forth the quarterly high and low closing sales prices of the Company's common shares, as reported by The NASDAQ Stock Market, since January 1, 1996.
1997 1996 --------------- --------------- HIGH LOW HIGH LOW ------ ------ ------ ------ First Quarter.......... $ 5.94 $ 5.13 $ 6.63 $ 6.00 Second Quarter......... 5.75 4.13 6.75 6.00 Third Quarter.......... 6.00 3.88 6.50 6.00 Fourth Quarter......... 5.75 4.88 6.06 5.50
The closing market price of the common shares on The NASDAQ Stock Market on March 20, 1998 was $8.00 per share. SHAREHOLDERS As of February 28, 1998, there were 162 shareholders of record and approximately 359 beneficial holders of the Company's common shares, and the number of common shares issued was 6,941,708 shares, which includes 494,617 common shares owned by a subsidiary of the registrant which are eligible to vote, and 1,660,125 common shares which were rescinded through litigation and are held by a court. See "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT." The provisions of Article XI of the Company's Articles of Association, which was adopted by the shareholders in 1988, prohibits business combinations lacking approval of the Continuing Directors (those not affiliated with a 20% or more shareholder) or 80% of the shareholders and may result in a prohibition against voting such shares held by a shareholder acquiring 20% or more of the common shares (and its affiliates and associates) if the Continuing Directors deny approval. In addition to the regulatory oversight of NAICO by the Nebraska Department of Insurance, the Company is also subject to regulation under the Nebraska Insurance Holding Company Systems Act (the "Holding Company Act"). In addition to various reporting requirements imposed on the Company, the Holding Company Act requires any person who seeks to acquire or exercise control over NAICO (which is presumed as to any person who owns 10% or more of the Company's outstanding voting stock) to file and obtain approval of certain applications with the Nebraska Department of Insurance regarding their current or proposed ownership of such shares. Non-compliance with the Holding Company Act may result in certain civil and criminal penalties or a requirement that the non-approved owner divest itself of such shares. DIVIDENDS The Company has never paid cash dividends on its common shares, and its current policy is to retain earnings to support its insurance operations. As a holding company, the Company depends primarily on share issuances, borrowings and dividends from its subsidiaries for its cash flow requirements. Any payment of future dividends will be dependent upon earnings of the Company's subsidiaries and their ability to pay shareholder dividends therefrom, financial requirements of the Company and its subsidiaries, business outlook, and other relevant factors. A significant portion of the Company's consolidated assets represents assets of the Company's insurance subsidiaries that may not be transferable to the holding company in the form of dividends, loans or advances. The Company's insurance subsidiaries are subject to various state statutory and regulatory restrictions, generally applicable to each insurance company in its state of incorporation, which limit the amount of dividends or distributions by an insurance company to its stockholders. The restrictions are generally based on certain levels of surplus, operating income and investment income, as determined under statutory accounting practices. The Holding Company Act regulates the distribution of dividends and other payments to the Company by its subsidiaries. Under the applicable Nebraska statute, the maximum discretionary dividend that may be declared (or cash/property distribution that may be made) by NAICO is the greater of (i) the insurance company's net income (excluding realized capital gains) for the preceding calendar year plus net income (excluding realized capital gains) from the second and third preceding calendar years (that was not paid in dividends or other distributions) or (ii) ten percent of the insurance company's policyholders' surplus for the preceding calendar year, excluding unrealized gains. These dividends are further limited by a clause in the Nebraska law which prohibits an insurer from declaring dividends except out of earned surplus of the company, as allowed under the Insurance Code. The payment of cash dividends by Chandler Barbados is limited to its realized earned surplus and margin of solvency requirements. Chandler Barbados and NAICO (during ownership by the Company) have not paid any cash shareholder dividends. FOREIGN ISSUER The Cayman Islands currently does not have any restrictions or exchange controls on the transfer of funds into and out of the Cayman Islands. Chandler Barbados is licensed as an "exempt insurance company", and Barbados currently does not have any restrictions or exchange controls for exempt insurance companies on the transfer of funds out of Barbados. If in the future the Company's assets are invested in foreign securities or held in currencies other than United States dollars, the Company will be subject to a risk of currency fluctuations and devaluations. See "BUSINESS--Regulation". PAGE 20 All or a substantial portion of the Company's assets are or may be located outside the United States. As a result, it may be difficult to obtain jurisdiction over or to enforce judgments against the Company in any legal proceeding by the Company's shareholders. Certain remedies available under United States securities laws may not be allowed in a Cayman Islands or Barbados court as a violation of their public policy. The operations of the Company and Chandler Barbados will be conducted in the Cayman Islands and Barbados, respectively, and may, therefore, be affected by changes in those governments and other economic and political conditions. ITEM 6. SELECTED FINANCIAL DATA The selected financial data has been derived from the consolidated financial statements of the Company and subsidiaries, which appear in Item 14(a). The consolidated balance sheets of the Company and its subsidiaries as of December 31, 1996 and 1997, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997, have been audited by Deloitte & Touche, independent auditors. The selected financial data should be read in conjunction with "LEGAL PROCEEDINGS", "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" and the consolidated financial statements of the Company and the notes thereto appearing in Item 14(a). See Notes to Consolidated Financial Statements for various litigation and contingency matters.
YEAR ENDED DECEMBER 31, - ------------------------------------------------ 1993 1994 1995 1996 1997 -------- -------- -------- -------- - -------- (Amounts in thousands except per share data and percentages) OPERATING DATA Revenues Net premiums earned........$ 79,300 $ 81,597 $ 81,087 $ 89,286 $ 94,679 Net investment income...... 12,087 8,675 8,053 7,339 8,017 Commissions, fees and other income............. 3,234 2,861 3,095 3,620 2,528 Total revenues................. 94,621 93,133 92,235 100,245 105,224 Operating expenses Losses and loss adjustment expenses...... 52,504 55,872 50,543 53,391 57,512 Policy acquisition costs... 25,742 20,372 23,995 32,123 28,145 General and administrative expenses................. 11,656 12,651 12,822 14,184 13,579 Litigation expenses, net... 2,051 1,921 285 (108) 4,772 Total operating expenses....... 91,953 90,816 87,645 99,590 104,008 Income before income taxes..... 2,668 2,317 4,590 655 1,216 Net income (loss).............. 3,698 2,474 3,778 972 (1,065) Basic and diluted earnings (loss) per common share (4)..................$ 0.53 $ 0.36 $ 0.54 $ 0.14 $ (0.16) Weighted average common shares outstanding......... 6,942 6,942 6,942 6,942 6,687 Combined loss and underwriting expense ratio (1).......... 107% 103% 101% 106% 100% BALANCE SHEET DATA Cash and investments...........$146,022 $124,501 $122,561 $119,136 $ 125,063 Total assets................... 286,447 261,364 246,949 206,827 210,790 Unpaid losses and loss adjustment expenses (2).... 179,815 156,060 128,794 79,639 74,929 Notes payable.................. - - 300 4,391 2,796 Litigation liabilities......... - - - - 16,618 Total liabilities (2).......... 218,265 197,905 173,499 134,280 152,455 Stock held by subsidiary, at cost................... (2,148) (2,148) (2,148) - (2,487) Stock rescinded through litigation................ - - - - (11,799) Shareholders' equity........... 68,182 63,459 73,450 72,547 58,335 Book value per share (3)....... 9.82 9.14 10.58 10.45 12.19 - ------------------------------- (1) Litigation expenses are not considered underwriting expenses; therefore, such expenses have been excluded from this ratio. The 1996 underwriting expense ratio was increased by 4 percentage points by a reinsurance arbitration adjustment and the termination of relations with the Company's former surety bond underwriting manager. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS". (2) For the years prior to 1994, the Company reclassified the liability NAICO assumes as a result of participating in various Pools from accrued taxes and other payables to unpaid losses and loss adjustment expenses. (3) Based on total common shares outstanding, less stock held by subsidiary and stock rescinded through litigation. See "LEGAL PROCEEDINGS - CenTra Litigation - Oklahoma". (4) The adoption of Statement of Financial Accounting Standard No. 128, EARNINGS PER SHARE did not have an impact on share and per share information.
PAGE 21 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL [References to the "Company" which follow within this Item 7 refer to the Company and its subsidiaries on a consolidated basis unless otherwise indicated.] The long-term success of an insurance company depends on its ability to carve out markets and maintain a competitive advantage in those markets. Many factors determine the profitability of an insurance company including rate competition; the frequency and severity of claims; the cost, availability and collectibility of reinsurance; interest rates; inflation; general business conditions; jury awards, court decisions and legislation expanding the extent of coverage and the amount of compensation due for injuries and losses. COMPETITION The property-casualty insurance industry is very competitive. Insurers compete on the basis of marketing effort, product, price, service and financial strength. The Company's competitors range from smaller regional independent insurance companies to major worldwide insurance companies. Many of the Company's competitors have substantially greater financial and other resources, and some offer a broader variety of coverages than those offered by the Company. A company's capacity to write insurance policies is dependent on a variety of factors including its net worth or "surplus", the lines of business written, the types of risk insured and its profitability. Since the late 1980's, the industry has generally had excess underwriting capacity. This condition has resulted in depressed premium rates and expanded policy terms, which generally occur in the industry when excess underwriting capacity exists. The Company continues to experience pricing competition in certain segments of its business as the conditions of heightened price competition and impaired underwriting performance continue in the industry as a whole. CLAIM COSTS AND LOSS RESERVES Insurance companies provide in their financial statements reserves for unpaid losses and loss adjustment expenses which are estimates of the expense of investigation and settlement of all reported and unreported losses under their previously issued insurance policies and/or reinsurance contracts. In estimating reserves, insurance companies use various standardized methods based on historical experience and payment and reporting patterns for the type of risk involved. The application of these methods necessarily involves subjective determinations by the personnel of the insurance company. Inherent in the estimates of the ultimate liability for unpaid claims are expected trends in claim severity, claim frequency and other factors that may vary as claims are settled. The amount of and uncertainty in the estimates are affected by such factors as the amount of historical claims experience relative to the development period for the type of risk, knowledge of the actual facts and circumstances, and the amount of insurance risk retained. The ultimate cost of insurance claims can be adversely affected by increased costs, such as medical, repair expenses, costs of providing legal defense for policyholders, increased jury awards, and court decisions and legislation that expand insurance coverage after the insurance policy was priced and sold. Accordingly, the loss and loss adjustment expense reserves may not accurately predict an insurance company's ultimate liability for unpaid claims. NAICO periodically reviews the reserve estimates relating to insurance business written or assumed by NAICO and Chandler Barbados and the methods used to arrive at such reserve estimates. NAICO also retains independent professional actuaries who review such reserve estimates and methods. Any changes in the estimates are reflected in current operating results. See Notes to Consolidated Financial Statements. The loss settlement period on insurance claims for property damage is relatively short. The more severe losses for bodily injury and workers compensation claims have a much longer loss settlement period and may be paid out over several years. It is often necessary to adjust estimates of liability on a loss either upward or downward between the time a claim arises and the time of payment. Workers compensation indemnity benefit reserves are determined based on statutory benefits described by state law and are estimated based on the same factors generally discussed above, with actuarial input, which may include, where state law permits, inflation adjustments for rising benefits over time. Generally, the more costly automobile liability claims involve one or more severe bodily injuries or deaths. The ultimate cost of these types of claims is dependent on various factors including the relative liability of the parties involved, the number and severity of injuries, and the legal jurisdiction where the incident occurred. The Company's subsidiaries report their reserves on the basis of U.S. GAAP. NAICO's statutory-based reserves do not differ from its U.S. GAAP reserves. Neither NAICO nor Chandler Barbados discounts its reserves for unpaid losses and loss adjustment expenses. PAGE 22 NAICO does not ordinarily insure against environmental matters as that term is commonly used. However, in some cases, regulatory filings made on behalf of an insured can make NAICO directly liable to the regulatory authority for property damage, which could include environmental pollution. In those cases NAICO ordinarily has recourse against the insured or the surety bond principal for amounts paid. NAICO has insured certain trucking companies and pest control operators who are required to provide proof of insurance which in some cases assures payment for clean-up and restoration of damage resulting from sudden and accidental release or discharge of contaminants or other substances which may be classified as pollutants. NAICO also provides surety bonds for construction contractors who use or have control of such substances and for contractors who remove and dispose of asbestos as a part of their contractual obligations. NAICO also insures independent oil and gas producers who may purchase coverage for the escape of oil, saltwater, or other substances which may be harmful to persons or property, but may not generally be classified as pollutants. Chandler Barbados reinsures a portion of those risks. The Company maintains claims records which segregate this type of risk for the purpose of evaluating environmental risk exposure. Based upon the nature of such lines of business with insureds of the Company, and current data regarding the limited severity and infrequency of such matters, it appears that potential environmental risks are not a significant portion of claims reserves and therefore would not likely have a material impact, if any, on the financial condition of the Company. REGULATION The Company's insurance subsidiaries are subject to regulation by government agencies in the jurisdictions in which they do business. The nature and extent of such regulation vary from jurisdiction to jurisdiction, but typically involve prior approval of the acquisition of control of an insurance company or of any company controlling an insurance company, regulation of certain transactions entered into by an insurance company with any of its affiliates, approval of premium rates, forms and policies used for many lines of insurance, standards of solvency and minimum amounts of capital and surplus which must be maintained, establishment of reserves required to be maintained for unearned premiums, losses and loss adjustment expenses or for other purposes, limitations on types and amounts of investments, restrictions on the size of risks which may be insured by a single company, licensing of insurers and agents, deposits of securities for the benefit of policyholders, and the filing of periodic reports with respect to financial condition and other matters. In addition, regulatory examiners perform periodic examinations of insurance companies. Such regulation is generally intended for the protection of policyholders rather than security holders. In addition to the regulatory oversight of the Company's insurance subsidiaries, the Company is also subject to regulation under the laws of the Cayman Islands and the Nebraska Insurance Holding Company System Act (the "Holding Company Act"). The Holding Company Act contains certain reporting requirements including those requiring the Company, as the ultimate parent company, to file information relating to its capital structure, ownership, and financial condition and general business operations of its insurance subsidiaries. The Holding Company Act contains special reporting and prior approval requirements with respect to transactions among affiliates. The Holding Company Act also imposes certain requirements upon any person controlling or seeking to control an insurance company domiciled in Nebraska. Persons owning any securities of the Company must comply with the Holding Company Act (see "BUSINESS - Regulation"). Insurance companies are also affected by a variety of state and federal legislative and regulatory measures and judicial decisions that define and extend the risks and benefits for which insurance is sought and provided. These include redefinitions of risk exposure in areas such as product liability, environmental damage and workers compensation. In addition, individual state insurance departments may prevent premium rates for some classes of insureds from reflecting the level of risk assumed by the insurer for those classes. Such developments may adversely affect the profitability of various lines of insurance. In some cases, these adverse effects on profitability can be minimized through re-pricing, if permitted by applicable regulations, of coverages or limitations or cessation of the affected business. ECONOMIC CONDITIONS The impact on the Company of a recession would depend on its duration and severity. A prolonged downturn in the economy could result in decreased demand for NAICO's insurance products and an increase in uncollectible premiums and/or reinsurance recoverables. In addition, an economic downturn could result in an increase in the number of insurance claims if insureds decrease expenditures that promote safety. Much of NAICO's insurance business is concentrated in the Southwest and Midwest areas of the United States. Approximately $89.7 million, or 73% of NAICO's direct written premiums in 1997 were in the states of Oklahoma and Texas. An economic downturn in these regions could have a significant impact on the Company. A recession might also cause defaults on fixed-income securities. Management believes it has mitigated the impact of a recession by employing conservative underwriting practices and strict credit policies and maintaining a high-quality investment portfolio. PAGE 23 Periods of inflation have varying effects on the Company's subsidiaries as well as other companies in the insurance industry. Inflation contributes to higher claims and related costs and operating costs as well as higher interest rates which generally provide for potentially higher interest rates on investable cash flow and decreases in the market value of existing fixed-income securities. Premium rates and commissions, however, are not significantly affected by inflation since competitive forces generally control such rates. NAICO's underwriting philosophy is to forego underwriting risks from which it is unable to obtain what it believes to be adequate premium rates. The effect of inflation on the operations of the Company was not significant during the period from 1995 through 1997. READINESS FOR YEAR 2000 Computer software, hardware, microprocessor chips and other computer equipment use two digits to identify a particular year, and therefore may not recognize the number "00" or may recognize it as a year prior to 1999. Unless computer equipment and software programs are modified to correct these problems ("Year 2000 Problems") errors could result. These errors could cause damage to personal property and disrupt business practices and functions. The Company has taken action to understand the nature and extent of the work required to make its systems, products and infrastructures Year 2000 compliant. NAICO began work in 1995 to prepare its financial, information and other computer-based systems for the Year 2000, including updating existing legacy systems, and such work is substantially complete at this time. NAICO continues to evaluate the estimated costs associated with future efforts based on actual experience. While these efforts may involve additional costs, the Company believes, based on available information, that it will be able to manage any significant effect on its business operations, products or financial prospects without incurring significant additional costs. The Company continues to study the complex issues related to insurance coverage for losses arising from the myriad potential fact situations connected with Year 2000 Problems. The Company believes that the coverages it provides do not extend to the types of losses which are most likely to occur as a result of Year 2000 Problems. The Company has made no provisions for reserves nor has it undertaken any modifications of its policy forms based on potential Year 2000 Problems. The Company may utilize coverage exclusion endorsements based on the individual underwriting of commercial accounts. It is possible, however, that future court interpretation of policy language based on specific facts could result in coverage for losses attributable to Year 2000 Problems. Such decisions could have a material adverse impact on the Company. It is also possible that the Company may incur expenses defending claims for which it is ultimately determined there is no insurance coverage. Likewise, the Company cannot predict the adverse impact, if any, of Year 2000 Problems upon its agents, customers, reinsurers and others who are or may be indebted to the Company. It is possible that the credit or ability of others with whom the Company maintains commercial relationships may be adversely affected by one or more unforeseen circumstances caused by Year 2000 Problems. ANALYSIS OF INSURANCE PROGRAM RESULTS OF OPERATIONS The following tables summarize the net premiums earned and the financial year (losses incurred and recognized by the Company regardless of the year in which the claim occurred) and accident year (losses incurred by the Company for a particular year regardless of the period in which the Company recognizes the costs) loss and loss adjustment expense ("LAE") ratios (computed by dividing losses and loss adjustment expenses by net premiums earned) in each of the years presented. The first table is summarized by major insurance program and includes all lines of insurance written in each program. The second table is summarized by line of insurance written and includes all net premiums earned and net losses and loss adjustment expenses incurred from all insurance programs for that particular line: PAGE 24
YEAR ENDED DECEMBER 31, - ------------------------------------ INSURANCE PROGRAM 1995 1996 1997 - ----------------------------------------- ---------- ---------- - ---------- (Dollars in thousands) STANDARD PROPERTY-CASUALTY Net premiums earned.................... $ 29,588 $ 38,330 $ 55,527 Financial year loss & LAE ratio........ 60.1 % 59.0 % 67.1 % Accident year loss & LAE ratio......... 59.3 % 60.8 % 63.3 % POLITICAL SUBDIVISIONS Net premiums earned.................... $ 12,472 $ 14,017 $ 14,945 Financial year loss & LAE ratio........ 61.1 % 57.6 % 56.8 % Accident year loss & LAE ratio......... 57.4 % 62.4 % 60.6 % SURETY BONDS Net premiums earned.................... $ 14,162 $ 10,020 $ 11,117 Financial year loss & LAE ratio........ 56.1 % (0.7)% 8.6 % Accident year loss & LAE ratio......... 46.1 % 37.0 % 11.3 % NONSTANDARD PRIVATE-PASSENGER AUTOMOBILE Net premiums earned.................... $ 15,234 $ 16,595 $ 8,841 Financial year loss & LAE ratio........ 83.2 % 86.2 % 72.2 % Accident year loss & LAE ratio......... 88.3 % 83.6 % 65.9 % TRANSPORTATION Net premiums earned.................... $ 3,098 $ 1,152 $ (171) Financial year loss & LAE ratio........ (2.3)% 338.4 % (925.2)% Accident year loss & LAE ratio......... 99.1 % 76.2 % (194.6)% OTHER Net premiums earned.................... $ 6,533 $ 9,172 $ 4,420 Financial year loss & LAE ratio........ 58.8 % 49.6 % 64.5 % Accident year loss & LAE ratio......... 73.8 % 48.6 % 47.7 % TOTAL Net premiums earned.................... $ 81,087 $ 89,286 $ 94,679 Financial year loss & LAE ratio........ 62.3 % 59.8 % 60.7 % Accident year loss & LAE ratio......... 64.8 % 61.8 % 56.7 % LINE OF INSURANCE - ----------------------------------------- WORKERS COMPENSATION Net premiums earned.................... $ 37,066 $ 42,813 $ 44,954 Financial year loss & LAE ratio........ 62.2 % 53.1 % 66.3 % Accident year loss & LAE ratio......... 57.8 % 56.4 % 67.6 % AUTOMOBILE LIABILITY Net premiums earned.................... $ 15,498 $ 17,581 $ 15,593 Financial year loss & LAE ratio........ 74.3 % 97.6 % 89.1% Accident year loss & LAE ratio......... 99.0 % 76.8 % 69.6% OTHER LIABILITY Net premiums earned.................... $ 6,579 $ 8,656 $ 12,209 Financial year loss & LAE ratio........ 42.9 % 59.9 % 48.5 % Accident year loss & LAE ratio......... 54.2 % 51.8 % 41.4 % SURETY AND FIDELITY BONDS Net premiums earned.................... $ 14,237 $ 10,123 $ 11,256 Financial year loss & LAE ratio........ 56.1 % (0.6)% 8.7 % Accident year loss & LAE ratio......... 45.8 % 36.8 % 11.4 % AUTOMOBILE PHYSICAL DAMAGE Net premiums earned.................... $ 5,881 $ 6,788 $ 5,726 Financial year loss & LAE ratio........ 68.3 % 73.6 % 59.8 % Accident year loss & LAE ratio......... 72.0 % 77.2 % 59.0 % ACCIDENT & HEALTH Net premiums earned.................... $ 230 $ 564 $ 2,529 Financial year loss & LAE ratio........ (48.5)% 56.1 % 43.1 % Accident year loss & LAE ratio......... 46.1 % 105.2 % 33.4 % PROPERTY Net premiums earned.................... $ 1,369 $ 1,467 $ 1,912 Financial year loss & LAE ratio........ 73.1 % 113.8 % 74.1 % Accident year loss & LAE ratio......... 84.3 % 109.5 % 67.6 % INLAND MARINE Net premiums earned.................... $ 227 $ 1,294 $ 500 Financial year loss & LAE ratio........ 84.1 % 114.7 % 194.6 % Accident year loss & LAE ratio......... 102.1 % 145.5 % 119.0 % TOTAL Net premiums earned.................... $ 81,087 $ 89,286 $ 94,679 Financial year loss & LAE ratio........ 62.3 % 59.8 % 60.7 % Accident year loss & LAE ratio......... 64.8 % 61.8 % 56.7 %
PAGE 25 NET INCOME (LOSS) A net loss of $1,065,000 resulted in 1997 compared to net income of $972,000 in 1996 and $3,778,000 in 1995. In 1997, the Company recorded a net charge totaling approximately $1.4 million ($1.6 million including provision for federal income tax) for the litigation matters related to the legal proceedings involving the CenTra Group. The ultimate actual amounts allowed by the Court to all parties could vary significantly from the Company's estimate. The net charge has been reduced by an estimated recovery of $2.7 million from the Company's directors and officers policy insurer for costs associated with the defense and litigation of these matters. See "LEGAL PROCEEDINGS". In addition, significant litigation expenses were incurred in 1997 due to the trial which began on February 13, 1997. The Company has also resolved various issues resulting in settlement of litigation and arbitration proceedings among subsidiaries of the Company and CenTra affiliates and recorded litigation and settlement expenses of approximately $462,000 in 1997. Excluding the effects of the litigation expenses and the estimated recovery, net income would have been approximately $3.4 million in 1997. Earnings for 1996 were affected by charges totaling $1.5 million for the settlement attributed to legal proceedings and related matters arising from the termination of an underwriting and production contract with the Company's former underwriting manager for a portion of the Company's surety bond program. In addition, legal expenses related to this matter were $441,000 for 1996. The Company's results for 1996 also reflect a charge totaling $1.1 million from an arbitration award that was lower than expected. Legal expenses related to the arbitration award were $527,000 in 1996. In 1996, the Company recorded a $982,000 estimated recovery of costs from its directors and officers liability insurer related to the Company's claim for reimbursable amounts previously paid for defense and litigation costs associated with the litigation involving the CenTra Group. Excluding the effects of the unusual charges and related expenses and the estimated recovery, net income would have been approximately $2.7 million for 1996. In 1995, the Company recorded an estimated recovery of $818,000 from the Company's directors and officers liability insurer. NET PREMIUMS EARNED Net premiums earned increased 1%, 10% and 6% in 1995, 1996 and 1997, respectively, compared to the prior years. In 1995, NAICO elected to commute the unpaid losses and loss adjustment expenses related to reinsurance contracts covering certain business written in 1993, 1994 and 1995 which resulted in an increase in net premiums earned of $2,285,000. Beginning in 1996, NAICO reviewed the historical results for reinsurance contracts with similar commutation provisions and began accruing for such commutations where a commutation election was considered likely. Excluding the effects of these commutation accruals and elections, net premiums earned decreased 2% in 1995, and increased 12% and 5% in 1996 and 1997, respectively. The effect of the commutation accruals and elections was to increase net premiums earned for each insurance program as follows:
YEAR ENDED DECEMBER 31, - ------------------------------ 1995 1996 1997 -------- -------- - -------- (Dollars in thousands) Standard property-casualty........................$ 1,223 $ 383 $ 946 Political subdivisions............................ 593 320 662 Other programs combined........................... 469 27 40 -------- -------- - -------- $ 2,285 $ 730 $ 1,648 ======== ======== ========
During 1993, NAICO expanded the standard property-casualty program by offering automobile liability and physical damage, general and umbrella liability and property coverages in addition to workers compensation and increased its marketing activity in Oklahoma and contiguous states, principally Texas. Excluding the effects of the commutations described above, net premiums earned for the standard property-casualty program increased 28%, 34% and 44% in 1995, 1996 and 1997, respectively, generally due to the product and territory expansion described above. Net premiums earned in the surety bond program decreased 29% in both 1995 and 1996 and increased 11% in 1997 compared to the prior years. NAICO and Midwest Indemnity Corporation ("Midwest"), the underwriting manager for a large portion of the surety bond program agreed to terminate the underwriting and production contract effective December 31, 1995. Midwest produced $1.0 million and $251,000 in gross written and assumed premiums in 1996 and 1997, respectively, during the runoff of that portion of the program. Midwest produced $8.2 million in gross written and assumed premiums in 1995. Direct surety premiums written for NAICO by L&W personnel were $4.8 million in 1995, $8.0 million in 1996 and $9.6 million in 1997. The increase is primarily a result of expansion in New Mexico and California. Excluding the effects of the commutations described above, net premiums earned for the political subdivisions program increased 10%, 15% and 4% in 1995, 1996 and 1997, respectively, from the prior years. Net premiums earned for the municipalities portion of this program increased 44%, 81% and 4% in 1995, 1996 and 1997, respectively. NAICO expanded its book of business through local agents in Oklahoma and expanded its coverage for municipalities to include workers compensation in 1995. NAICO also began insuring counties in 1995. Net premiums earned for the school districts portion of the program increased 3% in 1995, decreased 1% in 1996 and increased 4% in 1997. Expansion of the school districts program in Texas accounted for most of the 1997 increase. PAGE 26 NAICO participates in various mandatory pools covering workers compensation for insureds that were unable to purchase this coverage from an insurance company on a voluntary basis. In addition, NAICO receives assignments to write workers compensation for such insureds in certain states in lieu of participation in related pools. Net premiums earned from these direct assignments and participation in related pools were $6.8 million in both 1995 and 1996 and $1.3 million in 1997. The decline in 1997 was attributable to decreased activity from the pools and fewer assignments in certain states. Both the size of the involuntary market and NAICO's relative participation in states having a mandatory pool mechanism declined in 1996 and 1997. During late 1993, NAICO began writing nonstandard private-passenger automobile liability and automobile physical damage in Oklahoma. During mid- 1994, NAICO began writing these coverages in California and Arizona. Net premiums earned in each state were as follows:
YEAR ENDED DECEMBER 31, - ------------------------------ 1995 1996 1997 -------- -------- - -------- (Dollars in thousands) Oklahoma..........................................$ 4,438 $ 4,326 $ 1,485 Arizona........................................... 4,085 2,625 962 California........................................ 6,711 9,644 6,394 -------- -------- - -------- $ 15,234 $ 16,595 $ 8,841 ======== ======== ========
The 1997 decreases in Oklahoma and Arizona were generally a result of premium rate increases, reductions in the number of retail agents offering these programs and the discontinuance of these programs during 1997. During the second quarter of 1997, management reviewed the underwriting performance of the California portion of the program and concluded that it would be in the Company's best interest to substantially reduce its underwriting risk. Effective July 1, 1997, NAICO entered into a 100% quota share reinsurance agreement with Underwriters Reinsurance Company to fully reinsure the risk. In December 1997, the reinsurance contract was amended and Jefferson Insurance Company of New York replaced Underwriters Reinsurance Company. NAICO's largest underwriting manager was responsible for underwriting $11.5 million, $11.9 million and $12.3 million of NAICO's direct written and assumed premiums for the California and Arizona portions of the nonstandard private-passenger automobile program during 1995, 1996 and 1997, respectively. Premiums receivable and currently due from this underwriting manager were $596,000 and $612,000 at December 31, 1996 and 1997, respectively. In the second quarter of 1996, NAICO began writing excess accident and health coverage for small and medium sized employers generally in Oklahoma and Texas. Net premiums earned in this program were $316,000 and $2.3 million in 1996 and 1997, respectively. During the first quarter of 1994, management reviewed the underwriting performance of the transportation programs and concluded that it would be in the Company's best interest to discontinue writing transportation automobile liability business based on the underwriting results and other related factors. As a result, net premiums earned declined substantially from that point. The Company continues to service the transportation industry in its retail and risk brokerage operations and all risk management services provided by NAICO are available. INVESTMENT INCOME Net investment income decreased in 1996 compared to 1995 primarily as a result of a reduction in invested assets and a decrease in net realized capital gains. Invested assets declined primarily as a result of the payment of loss and loss adjustment expense reserves corresponding to the planned reduction of certain insurance programs within the Company's book of insurance business during 1991 through 1994. Net investment income increased 9% in 1997 compared to the prior year primarily as a result of an increase in net realized capital gains. Net realized capital gains were $412,000, $140,000 and $764,000 in 1995, 1996 and 1997, respectively. The average net yield on the portfolio, including net realized capital gains, was 6.5% in 1995, 6.1% in 1996 and 6.6% in 1997. The 1997 net realized capital gains resulted primarily from NAICO shifting a portion of its fixed maturities portfolio from taxable to tax exempt bonds and NAICO's sale of Century Business Services, Inc. common stock. The Century Business Services stock was received in early 1997 as a part of a 1996 settlement with a former underwriting manager. The average net yield excluding net realized capital gains for these years was 6.1%, 6.0% and 5.9%, respectively. COMMISSIONS, FEES AND OTHER INCOME L&W's brokerage commissions and fees before intercompany eliminations were $8.2 million in 1995, $8.5 million in 1996 and $9.0 million in 1997. A large portion of the brokerage commission and fees for L&W is incurred by NAICO and thus eliminated in the consolidation of the Company's subsidiaries. Commissions and fees generated by Network were $148,000 in 1995, $722,000 in 1996 and $435,000 in 1997. Network is a third-party administrator of partially self-insured group accident and health plans. The Company acquired Network in the fourth quarter of 1995. Network's operations were consolidated into a joint venture in the third quarter of 1997. Effective December 31, 1997, Network's participation in the joint venture was terminated and Network no longer functions as a third-party administrator. PAGE 27 LOSSES AND LOSS ADJUSTMENT EXPENSES The Company estimates losses and loss adjustment expenses based on historical experience and payment and reporting patterns for the type of risk involved. These estimates are based on data available at the time of the estimate and independent professional actuaries periodically review such estimates. The percentage of losses and loss adjustment expenses to net premiums earned was 62.3%, 59.8% and 60.7% in 1995, 1996 and 1997, respectively. In 1996, the Company decreased the estimated ultimate loss ratio of a substantial portion of the surety bond program, which decreased the loss ratio by 3.1 percentage points. This decrease was offset by corresponding adjustments to policy acquisition costs. In addition, the loss commutations discussed previously decreased the 1995, 1996 and 1997 loss ratios by 1.8, 0.5 and 1.1 percentage points, respectively. POLICY ACQUISITION COSTS Policy acquisition costs consist of costs associated with the acquisition of new and renewal business and generally include direct costs such as premium taxes, commissions to agents and ceding companies and premium-related assessments and indirect costs such as salaries and expenses of personnel who perform and support underwriting activities. NAICO also receives ceding commissions from certain of the reinsurers who assume premiums from NAICO under certain reinsurance contracts and the ceding commissions are accounted for as a reduction of policy acquisition costs. Direct policy acquisition costs and ceding commissions are deferred and amortized over the terms of the policies. Recoverability of such deferred costs is dependent on the related unearned premiums on the policies being more than expected claim losses. The following table sets forth the Company's policy acquisition costs for each of the three years ended December 31, 1995, 1996 and 1997:
YEAR ENDED DECEMBER 31, - ------------------------------------ 1995 1996 1997 ---------- ---------- - ---------- (Dollars in thousands) Commissions expense.........................$ 11,506 $ 16,489 $ 15,860 Other premium related assessments........... 1,704 1,258 744 Premium taxes............................... 2,486 2,705 3,400 Excise taxes................................ 138 109 153 Dividends to policyholders.................. 434 454 1,155 Other expense............................... 168 365 146 ---------- ---------- - ---------- Total direct expenses....................... 16,436 21,380 21,458 Indirect underwriting expenses.............. 10,515 14,831 13,464 Commissions received from reinsurers........ (3,162) (2,895) (6,458) Adjustment for deferred acquisition costs... 206 (1,193) (319) ---------- ---------- - ---------- Net policy acquisition costs................$ 23,995 $ 32,123 $ 28,145 ========== ========== ==========
Total gross direct and indirect expenses as a percentage of direct written and assumed premiums were 27.3%, 33.5% and 28.4% in 1995, 1996 and 1997, respectively. For these periods, the average commission rates were 11.6%, 15.3% and 12.9%. The commission rate for a substantial portion of the surety bond program varies inversely with the loss ratio pursuant to a commission arrangement contingent on the loss experience of the program. The expected loss ratio for that portion of the surety bond program was lowered in 1996 and that decrease increased the percentage of net policy acquisition costs to net premiums earned by 3.1 percentage points. Indirect expenses were 10.6%, 13.7% and 10.9% of total direct written and assumed premiums in 1995, 1996 and 1997, respectively. Indirect expenses include general overhead and administrative costs associated with the acquisition of new and renewal business, some of which is relatively fixed in nature, thus, the percentage of such expenses to direct written and assumed premiums will vary depending on the Company's overall premium volume. The Company incurred $1,534,000 in indirect underwriting expenses related to the Midwest termination settlement, which was 1.4% of direct written and assumed premiums in 1996. Commissions received from reinsurers increased in 1997 as a result of the 100% quota share reinsurance arrangement for the California portion of the nonstandard private-passenger automobile program which was effective July 1, 1997. NAICO ceded premiums of $7,473,000 and received commissions totaling $1,868,000 under this quota-share reinsurance arrangement. The Company incurred $440,000, $2,078,000 and $527,000 in indirect underwriting expenses for uncollectible ceded reinsurance in 1995, 1996 and 1997, respectively, which was 0.4%, 1.9% and 0.4% of direct written and assumed premiums in those periods. The 1996 amount includes an arbitration award which was made against New York Life Insurance Company, Security Benefit Life Insurance Company and Standard Insurance Company and in favor of NAICO but for $1.1 million less than had been expected. NAICO reduced its reinsurance recoverables accordingly. See Notes to Consolidated Financial Statements. PAGE 28 GENERAL AND ADMINISTRATIVE EXPENSES General and administrative expenses were 15.2%, 15.3% and 14.0% of revenues exclusive of net investment income in 1995, 1996 and 1997, respectively. General and administrative expenses have historically not varied in direct proportion to the Company's revenues. A portion of such expenses is allocated to policy acquisition costs (indirect underwriting expenses) and loss and loss adjustment expenses based on various factors including employee counts, salaries, occupancy and specific identification. Because certain types of expenses are fixed in nature, the percentage of such expenses to revenues will vary depending on the Company's overall premium volume. In 1996, the Company incurred $441,000 in legal expenses related to the Midwest termination settlement, and $527,000 in legal expenses related to the reinsurance arbitration discussed above. LIQUIDITY AND CAPITAL RESOURCES The Company is a holding company receiving cash principally through equity sales, borrowings and subsidiary dividends, subject to various regulatory restrictions described in "Regulation" and Notes to Consolidated Financial Statements. The capacity of insurance and reinsurance companies to underwrite insurance and reinsurance is based on maintaining liquidity and capital resources sufficient to pay claims and expenses as they become due. The primary sources of liquidity for the Company's subsidiaries are funds generated from insurance and reinsurance premiums, investment income, capital contributions from the Company and proceeds from sales and maturities of portfolio investments. The principal expenditures are payment of losses and loss adjustment expenses, insurance operating expenses and commissions. All significant Company subsidiaries maintain liquid operating positions and follow investment guidelines that are intended to provide for an acceptable return on investment while preserving capital, maintaining sufficient liquidity to meet obligations and keeping a sufficient margin of capital and surplus to ensure unimpaired ability to write insurance and assume reinsurance. Fixed-maturity investments are purchased to support the investment strategies of the Company and its subsidiaries, which are developed based on many factors including rate of return, maturity, credit risk, tax considerations, regulatory requirements and their mix of business. At the time of purchase, investments in debt securities that the Company has the positive intent and ability to hold to maturity are classified as held to maturity and reported at amortized cost; all other debt securities are reported at fair value. Investments classified as trading are actively and frequently bought and sold with the objective of generating income on short-term differences in price. Realized and unrealized gains and losses on securities classified as trading account assets are recognized in current operations. The Company has not classified any investments as trading account assets. Securities not classified as held to maturity or trading are classified as available for sale, with the related unrealized gains and losses excluded from earnings and reported net of tax as a separate component of shareholders' equity until realized. In 1997, NAICO provided $5.1 million in cash from operations and Chandler Barbados used $2.9 million cash in operations. To augment maturities and reposition their portfolios, Chandler Barbados and NAICO chose to liquidate certain fixed maturity securities that were available for sale prior to their maturities. In addition, NAICO sold the common stock of Century Business Services, Inc. (formerly International Alliance Services, Inc.) for a total of $2,459,000. The Century Business Services common stock was received as a part of its 1996 settlement with Midwest. The Company realized net capital gains before income taxes in 1997 in the amount of $764,000 from the sale of investments. In 1997, Chandler Barbados and NAICO received proceeds of $3.5 million and $18.7 million, respectively, from the sale of fixed-income securities that were available for sale prior to their maturity. The average maturity of the Company's investments was 4.81 years and 4.59 years at December 31, 1996 and 1997, respectively. During 1996, Chandler USA borrowed $4.5 million from a bank on a three year note payable. The note had a floating interest rate at Wall Street Journal Prime and principal and interest are payable monthly. Proceeds from the note were used to repay intercompany advances from Chandler Barbados. During the fourth quarter of 1997, the related loan agreement was amended to provide for additional borrowings up to $8.5 million and to revise the term to five years with interest payable at a floating rate equal to 1% over Wall Street Journal Prime, which was 8.5% at December 31, 1997. The note is collateralized by the shares of NAICO stock owned by Chandler USA and includes certain loan covenants. The outstanding balance of the note was $2,646,000 at December 31, 1997. All or a portion of the available borrowing capacity under the note may be used to post needed bonds or to discharge judgments entered in the CenTra litigation. The Company is considering a number of options to deal with these issues and believes it has made appropriate provision based upon known facts. Chandler Barbados is required as a foreign reinsurer to secure reserves for unpaid losses and loss adjustment expenses and unearned premiums for the benefit of the primary insurer ceding such amounts. Chandler Barbados secures such amounts by trust arrangements whereby securities are deposited into a trust account for the benefit of the primary insurer. NAICO is required to deposit securities with regulatory agencies in several states in which it is licensed as a condition of conducting operations in the state. NAICO also has deposited funds pursuant to a trust arrangement securing reinsurance obligations it has assumed from an unrelated primary carrier. At December 31, 1997, the total amount of cash and investments restricted for Chandler Barbados and NAICO as a result of these arrangements was $16.7 million and $8.5 million, respectively. PAGE 29 CENTRA LITIGATION In 1992, the Company became involved in certain legal proceedings beyond the ordinary course of business. These proceedings generally involve CenTra. The Company has incurred approximately $2.5 million, $2.1 million, $1.9 million, $1.1 million, $857,000 and $7.5 million in costs attributable to these legal proceedings during 1992, 1993, 1994, 1995, 1996 and 1997, respectively, before recoveries from the Company's directors and officers policy insurer. The amount for 1997 includes approximately $1.4 million for the Oklahoma Federal Court judgments, $2.9 million for litigation expenses and $462,000 related to the settlement of certain litigation and arbitration proceedings. As a result of various events in 1995, the Company recorded an $818,000 estimated recovery of costs from its directors and officers policy insurer related to a $1 million claim for reimbursable amounts previously paid that relate to allowable defense and litigation costs for such parties. In 1996, the Company recorded an additional estimated recovery of $982,000. The Company received a payment for the 1995 claim during 1996 in the amount of $795,000. In connection with the Oklahoma Federal Court judgments, the Company recorded an additional estimated recovery of $2.7 million from the Company's directors and officers policy insurer. The Company is entitled to a total of $5 million under the applicable insurance policy. Some amounts have been previously paid without dispute and the Company is negotiating with the insurer for payment of the policy balance. The Company could recover the remaining policy limits or could compromise its claim, and could incur significant costs in either case. The estimated insurance recovery is based upon these variable factors. See "Liquidity and Capital Resources", "LEGAL PROCEEDINGS" and Notes to Consolidated Financial Statements. NAICO and NAICO Indemnity provided insurance coverage and risk management services for CenTra and certain of its affiliates. All such policies were canceled effective September 5, 1992 or expired as of September 30, 1992. As of December 31, 1997, the unpaid premiums and other amounts due from CenTra to the Company's subsidiaries were $788,625 as reflected by the April 22, 1997 jury verdicts. The Company intends to seek payment of all amounts due and believes a reserve for collection is not necessary at December 31, 1997. In addition, the Company's subsidiaries reflected a payable to certain affiliates of CenTra in the amount of $505,000 at December 31, 1997 in connection with the settlement of certain litigation and arbitration proceedings. See "LEGAL PROCEEDINGS". The Company's management believes that adequate financial resources are available to post a supersedeas bond if the judgments are appealed, and the Company is pursuing various financing arrangements in the event that the judgments are not reduced or overturned. As a holding company, the Company may receive cash through equity sales, borrowings and dividends from its subsidiaries. Chandler Barbados and NAICO are subject to various regulations which restrict their ability to pay shareholder dividends. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Liquidity and Capital Resources". A reduction in the amount of invested assets, or an increase in borrowings resulting from potential payment of these judgments would reduce investment earnings or increase operating expenses in future periods. CERTAIN TAX MATTERS During 1996, the IRS conducted a field examination of the U.S. Federal income tax returns of Chandler USA and its wholly owned subsidiaries for the years 1993 and 1994. The IRS completed the examination in the fourth quarter of 1996, and there were no proposed adjustments to tax liabilities. ACCOUNTING STANDARDS ISSUED BUT NOT YET ADOPTED In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 130, REPORTING COMPREHENSIVE INCOME, which establishes standards for reporting and displaying comprehensive income and its components (revenues, expenses, gains and losses) in financial statements. In addition, SFAS No. 130 requires the Company to classify items of other comprehensive income by their nature in a financial statement and display the accumulated balance of other comprehensive income separately in the shareholders' equity section of the consolidated balance sheets. The Company will adopt SFAS No. 130 on January 1, 1998 as required. Also in June 1997, the FASB issued SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION. SFAS No. 131 establishes reporting standards for public companies concerning annual and interim financial statements of their operating segments and related information. Operating segments are components of a company about which separate financial information is available that is regularly evaluated by the chief operating decision maker(s) in deciding how to allocate resources and assess performance. The Standard sets criteria for reporting disclosures about a company's products and services, geographic areas and major customers. The Company will adopt SFAS No. 131 on January 1, 1998 as required. FORWARD-LOOKING STATEMENTS Some of the statements made in this Form 10-K report, as well as statements made by the Company in periodic press releases, oral statements made by the Company's officials to analysts and shareholders in the course of presentations about the Company and conference calls following earnings releases, constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Such factors include, among other things, (i) general economic and business conditions; (ii) interest rate changes; (iii) competition and regulatory environment in which the Company operates; (iv) claims frequency; (v) claims severity; (vi) the number of new and renewal policy applications submitted by the Company's agents; and (vii) other factors such as the ongoing litigation matters involving a significant concentration of ownership of common stock. PAGE 30 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See Item 14. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT DIRECTORS AND EXECUTIVE OFFICERS A brief description of each director and executive officer of the Company is provided below. Directors hold office until the next annual meeting of shareholders or until their respective successors are duly elected and qualified. Executive officers are elected by the Board of Directors at its annual meeting and hold office until its next annual meeting or until their respective successors are duly elected and qualified. The current directors and executive officers of the Company are as follows:
NAME AGE POSITION - --------------------------- --- -------------------------------------------- W. Brent LaGere............ 52 Chairman of the Board, Chief Executive Officer, President, Executive Committee Chairman, Investment Committee Member and Director. Brenda B. Watson........... 57 Executive Vice President, Executive Committee Member and Director. Richard L. Evans........... 51 Vice President and Director. Mark T. Paden.............. 41 Vice President - Finance, Chief Financial Officer, Treasurer, Investment Committee Member and Director. Steven R. Butler........... 40 Vice President - Administration. Norman E. Harned........... 57 Director. James M. Jacoby............ 63 Audit Committee Member, Option and Compensation Committee Chairman and Director. Ronald W. Lech............. 68 Director. Paul A. Maestri............ 67 Audit Committee Member, Option and Compensation Committee Member and Director. M. J. Moroun............... 70 Investment Committee Member, Executive Committee Member and Director. Robert L. Rice............. 63 Audit Committee Chairman, Executive Committee Member, Option and Compensation Committee Member and Director. Larry A. Davis............. 56 Director.
W. BRENT LAGERE has been Chairman of the Board of the Company since September 1983, Chief Executive Officer since March 1986 and President since May 1997. Since October 1988 he has served in officer and director capacities for various subsidiaries of the Company pursuant to an employment contract with Chandler USA. Since 1971 he has served in various capacities with L&W. PAGE 31 BRENDA B. WATSON has been Executive Vice President of the Company since October 1988, was a Vice President of the Company for three years prior thereto, and has been a director of the Company since September 1985. Since October 1988 she has served in officer and director capacities for various subsidiaries of the Company pursuant to an employment contract with Chandler USA. RICHARD L. EVANS has been a director of the Company since September 1983. He has been a Vice President of the Company since August 1986, and since May 1989, he has been an employee of Chandler USA. Mr. Evans has served L&W since 1979 in various capacities. Mr. Evans has also been a director of Chandler USA since May 1990. MARK T. PADEN has served as Vice President-Finance of the Company since August 1987 and director since May 1992. Since February 1987 Mr. Paden has been an employee of L&W and/or Chandler USA. Mr. Paden has served as the Vice President-Finance and Chief Financial Officer of NAICO since January 1988 and Vice President-Finance and Chief Financial Officer of L&W since May 1987. Mr. Paden has also been a director of Chandler USA since July 1988, NAICO since November 1992 and L&W since October 1992. STEVEN R. BUTLER has served as Vice President-Administration of the Company since January 1987, and also serves as a director, the President and Treasurer of CIM Barbados. He is also a director and the Financial Director of CIM. The Company began handling its own and Chandler Barbados' operations and administrative affairs through CIM and CIM Barbados, respectively, in 1990. From 1984 through 1989, Mr. Butler served as Financial Director of Insurance Management Services, Ltd. and, beginning in 1988, of its affiliate Insurance Risk Management Services, Ltd., which performed substantially all of the administrative management functions of the Company and Chandler Barbados, respectively, through March 1990. NORMAN E. HARNED has been a director of the Company since 1989. Mr. Harned has served as Vice President of CenTra for more than five years. JAMES M. JACOBY has been a director since October 1993. He has been a director of NAICO since August 1990. He has been an insurance agent for more than five years and was formerly employed by NAICO from June 1990 to March 1991. Mr. Jacoby retired in September 1994 from Alexander and Alexander, Inc. and is currently employed by Constructor's Bonding & Insurance in Omaha, Nebraska. RONALD W. LECH has been a director since June 1992. Until June 2, 1995, Mr. Lech had been an Executive Vice President of CenTra for more than five years, but is currently retired. PAUL A. MAESTRI has been a director of the Company since October 1985. Since February 1990 Mr. Maestri has engaged in personal investment activities. From 1980 to February 1990 Mr. Maestri was a director and the President and Chief Executive Officer of P.A.M. Transport, Inc. He has also been a director of L&W since December 1993 and of NAICO since May 1997. M. J. MOROUN has been a director of the Company since 1989. Mr. Moroun has been Chief Executive Officer of CenTra for more than five years. ROBERT L. RICE has been in private practice as a certified public accountant for more than five years and a director of the Company since May 1987. Mr. Rice has also been a director of Chandler USA since June 1993 and of L&W since May 1997. LARRY A. DAVIS has been a director of the Company since August 1997. Mr. Davis has also been a director of Chandler Barbados and CIM Barbados since December 1992. Currently Mr. Davis is employed by Loewen Financial Corporation, a Barbados corporation. COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934 Based solely upon a review of Forms 3, 4 and 5, any amendments thereto furnished to the Company pursuant to the rules of the Securities and Exchange Commission, or written representations from certain reporting persons presented to the Company, all such reports required to be filed by reporting persons have been filed in a timely fashion during the fiscal year ended December 31, 1997. PAGE 32 ITEM 11. EXECUTIVE COMPENSATION The following table sets forth the compensation paid or to be paid by the Company or any of its subsidiaries as well as certain other compensation paid or accrued, during the years indicated, to the Chairman and Chief Executive Officer and the four other highest paid executive officers of the Company (the "named executives") for such period in all capacities in which they served.
SUMMARY COMPENSATION TABLE LONG TERM COMPENSATION ------------------------------- ANNUAL COMPENSATION (1) AWARDS PAYOUTS - ----------------------------- --------------------- ------- OTHER RESTRICTED ANNUAL STOCK OPTIONS/ LTIP ALL OTHER SALARY BONUS COMPENSA- AWARD(S) SARS PAYOUTS COMPENSA- NAME AND PRINCIPAL POSITION YEAR ($) ($) TION($)(2) ($) (#) ($) TION ($)(4) - ---------------------------------------- ---- -------- ----- - ---------- ---------- -------- ------- ----------- W. Brent LaGere 1997 $389,340 $ - N/A - - - $ 37,471 Chairman of the Board, CEO and 1996 378,610 - N/A - - - 40,148 President of Chandler USA, NAICO 1995 373,369 - N/A - - - 28,113 and L&W Benjamin T. Walkingstick (3) 1997 334,123 - N/A - - - 15,625 Former President of Chandler USA, 1996 314,321 - N/A - - - 41,052 NAICO and L&W; and former 1995 312,294 - N/A - - - 29,400 Treasurer of L&W Brenda B. Watson 1997 216,882 - N/A - - - 8,475 Executive Vice President of 1996 211,182 - N/A - - - 15,552 NAICO and L&W 1995 206,154 - N/A - - - 4,500 Richard L. Evans 1997 211,873 - N/A - - - 6,275 Vice President-Claims of 1996 205,896 - N/A - - - 13,752 Chandler USA, NAICO and L&W 1995 199,939 - N/A - - - 3,000 Mark T. Paden 1997 178,637 - N/A - - - 4,975 Vice President-Finance & CFO of 1996 173,188 - N/A - - - 12,752 Chandler USA, NAICO and L&W 1995 168,218 - N/A - - - 2,000 Steven R. Butler 1997 127,514 12,850 N/A - - - - President of CIM and CIM Barbados 1996 122,610 14,554 N/A - - - - 1995 117,757 14,710 N/A - - - - - ---------------------------------------- (1) Amounts shown include cash and non-cash compensation earned and received by the named executives as well as amounts earned but deferred at their election. (2) The Company provides various perquisites to certain employees including the named executives. In each case, the value of the perquisites provided to the named executives did not exceed ten percent of such named executives' annual salary and bonus. (3) Mr. Walkingstick resigned his positions as President of Chandler USA, NAICO and L&W effective May 1, 1997. The 1997 amounts above include Mr. Walkingstick's compensation subsequent to his resignation pursuant to an Employment Agreement. See "Employment Agreements". (4) The amounts shown under this column represent contributions by the Company's U.S. subsidiaries to a 401(k) plan ($1,000 for each of the named executives in 1995, $11,552 in 1996 and $3,475 in 1997 (except for Mr. Walkingstick whose 1997 contribution was $1,625)) and the premiums paid or to be paid by the Company's U.S. subsidiaries under life insurance arrangements with the named executives. A portion of the premiums ($32,100, $34,500 and $24,300 in 1995, 1996 and 1997, respectively) were paid under split dollar life insurance plans. Under these plans, the Company's U.S. subsidiaries pay the premiums for life insurance issued to the named executive. Repayment of the premiums is secured by the death benefit or the cash surrender value of the policy, if any, if the executive cancels and surrenders the policy.
OPTIONS EXERCISED AND HOLDINGS No options were exercised during 1997 and there were no unexercised options held as of December 31, 1997. DIRECTOR COMPENSATION Messrs. Harned, Lech, Maestri, Moroun, Jacoby, Davis and Rice -- the Company's outside directors -- receive an annual retainer of $6,000 and $1,000 for each meeting. These outside directors are compensated at the rate of $1,000 per day for time spent on board-related activities. Due primarily to time spent in connection with certain litigation, Messrs. Maestri, Rice and Jacoby received total director compensation during 1997 of $82,750, $75,250 and $43,500, respectively. See "LEGAL PROCEEDINGS - CenTra Litigation". PAGE 33 EMPLOYMENT AGREEMENTS Chandler USA has employment agreements with Mr. LaGere and Ms. Watson. The agreements contain self-renewing terms of five years limited to the employee attaining age 70. The salary amounts reflected in the foregoing table represent amounts paid as required by the contracts for the years indicated. Under certain limited circumstances, such officers could receive base salaries subsequent to an early termination of their employment subject to certain continued obligations to Chandler USA. Prior to May 1, 1997, Benjamin T. Walkingstick was an employee of Chandler USA pursuant to an employment agreement dated October 28, 1988, (the "Employment Agreement") and served as an executive officer and director of the Company and certain of its subsidiaries. Effective May 1, 1997, Mr. Walkingstick resigned these positions and ceased to be an employee of Chandler USA. He continues to be a consultant to Chandler USA and its subsidiaries pursuant to the Employment Agreement and continues to receive compensation at an annual rate of $323,291 under the Employment Agreement through October 2000 at which time he reaches age 70. See "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS". Chandler USA entered into employment contracts with three employees of Network in October 1995. Two of the contracts have been terminated and one with an initial five year term remains in effect. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table lists the directors and executive officers (including a former executive officer and director of the Company) of the Company and provides information on their ownership of the Company's common shares at February 28, 1998:
BENEFICIAL OWNERSHIP - --------------------------- NUMBER OF NAME OF DIRECTOR OR EXECUTIVE OFFICER SHARES (1) PERCENT (2) - -------------------------------------------------- ------------- - ----------- W. Brent LaGere................................... 401,813 (3) 6.2% Benjamin T. Walkingstick.......................... 401,029 (4) 6.2% Brenda B. Watson.................................. 35,542 * Richard L. Evans.................................. 32,750 * Norman E. Harned.................................. 3,135,700 (5) 48.6% Paul A. Maestri................................... - - M.J. Moroun....................................... 3,135,700 (6) 48.6% James M. Jacoby................................... - - Robert L. Rice.................................... - - Mark T. Paden..................................... 1,200 * Ronald W. Lech.................................... 3,135,700 (5) 48.6% Larry A. Davis.................................... - - Steven R. Butler.................................. 1,000 * All directors and officers as a group (13 persons) 3,964,034 61.5% - -------------------------------------------------- * Less than 1% (1) Except as otherwise indicated, each person has the sole power to vote and dispose of all shares, and the sole power to exercise any options listed opposite his or her name. (2) In the above table, any shares that a person can acquire through the exercise of options are deemed to be outstanding solely for the purpose of computing the number and percentage of the Company's common shares that he or she owns. Such shares, if any, are not included in the computations for any other person. These percentages are computed based on the number of outstanding common shares including 1,660,125 common shares rescinded through litigation but excluding 494,617 common shares owned by a subsidiary of the Company which are eligible to vote. Elsewhere in this Form 10-K, references to the number or percentage of the Company's common shares that a person owns do not reflect common shares issuable under outstanding options, if any. (3) Includes (i) 348,390 common shares owned by the W. Brent LaGere Irrevocable Trust; and (ii) 45,000 common shares owned by W&L Holding Corp. ("W&L Holding"), a corporation 49% of which is owned by the W. Brent LaGere Irrevocable Trust. Mr. LaGere disclaims beneficial ownership of the shares held by W&L Holding and the trust. The power to vote and dispose of the shares held by W&L Holding is shared with Benjamin T. Walkingstick, who also owns 49% of W&L Holding. (4) Includes 45,000 common shares owned by W&L Holding, a corporation 49% of which is owned by Mr. Walkingstick. The power to vote and dispose of the shares held by W&L Holding is shared with the W. Brent LaGere Irrevocable Trust, which also owns 49% of W&L Holding. (5) Comprised of (i) 250 common shares held by Mr. Harned; (ii) 2,000 shares held by Mr. Lech; and (iii) the other shares beneficially owned by M.J. Moroun. See footnote (6) below and "Other Matters Regarding Beneficial Ownership". (6) Includes (i) 1,360,125 common shares owned by CenTra; and (ii) 1,441,700 common shares owned by Can-Am; (iii) 290,000 common shares owned by Ammex, Inc. ("Ammex"); (iv) 25,000 common shares owned by DuraRock, which is owned by Matthew T. Moroun, M.J. Moroun's son; (v) 15,000 common shares owned by Matthew T. Moroun; (vi) 250 common shares held by Mr. Harned; (vii) 2,000 common shares held by Mr. Lech; and (viii) 1,625 common shares owned by Agnes A. Moroun, M.J. Moroun's sister. See "Possible Change of Control" and "Other Matters Regarding Beneficial Ownership" regarding the Company's assumptions about beneficial ownership and the presence of certain restrictions on the voting and disposition of the common shares beneficially owned by Messrs. M.J. Moroun, Harned, Lech, Agnes A. Moroun and Matthew T. Moroun.
PAGE 34 SHAREHOLDERS HOLDING OVER FIVE PERCENT Listed below are persons, other than those listed previously, who are known by the Company to own beneficially more than 5% of the Company's common shares as of February 28, 1998. Except as otherwise indicated, each of the persons named below has sole voting and investment power with respect to the common shares beneficially owned.
BENEFICIAL OWNERSHIP - --------------------------- NUMBER OF NAME OF SHAREHOLDER SHARES (1) PERCENT (2) - -------------------------------------------------- ------------- - ----------- CenTra Group (CenTra, Can-Am, Ammex and Messrs. M.J. Moroun, Ronald Lech and Norman Harned, Agnes A. Moroun and Matthew T. Moroun) 12225 Stephens Road, Warren, Michigan 48089........ 3,135,700 (3) 48.6% Marvel List,(Trustee of the W. Brent LaGere Irrevocable Trust) 420 Bennett Boulevard, Chandler, Oklahoma 74834.... 398,077 6.2% Brinson Partners, Inc 209 S. LaSalle, Chicago, Illinois 60604............ 663,000 (4) 10.3% - ----------------------------------------------------- (1) Except as otherwise indicated, each person or group has the sole power to vote and dispose of all shares and the sole power to exercise any options listed opposite his or her name. (2) In the above table, any shares that a person can acquire through the exercise of options are deemed to be outstanding solely for the purpose of computing the number and percentage of the Company's common shares that he or she owns. Such shares, if any, are not included in the computations for any other person. These percentages are computed based on the number of outstanding common shares including 1,660,125 common shares rescinded through litigation but excluding 494,617 common shares owned by a subsidiary of the Company which are eligible to vote. Elsewhere in this Form 10-K, references to the number or percentage of the Company's common shares that a person owns do not reflect common shares issuable under outstanding options, if any. (3) The CenTra Group has filed a Schedule 13D with the Securities and Exchange Commission reporting collective beneficial ownership of 49.2% of the Company's common shares as of July 1992. This percentage included certain common shares the CenTra Group had contracted to acquire subject to regulatory approval and was calculated based on total outstanding shares of 7,509,058. A Schedule 13D is filed by a person (or group of persons acting collectively) who owns five percent or more of a reporting company's stock. The beneficial ownership set forth above includes: (i) 1,360,125 common shares owned by CenTra; and (ii) 1,441,700 common shares owned by Can-Am; (iii) 290,000 common shares owned by Ammex; (iv) 25,000 common shares owned by DuraRock, which is owned by Matthew T. Moroun, M.J. Moroun's son; and (v) 15,000 common shares owned by Matthew T. Moroun; (vi) 250 common shares held by Mr. Harned; (vii) 2,000 common shares held by Mr. Lech; and (viii) 1,625 common shares owned by Agnes A. Moroun, M.J. Moroun's sister. The Company includes the ownership of Messrs. Harned and Lech and Agnes A. Moroun in the beneficial ownership of the CenTra Group because of their present or former employment and other relationships with CenTra and M.J. Moroun and their involvement in CenTra's attempts to take control of the Company. See "Possible Change of Control" and "Other Matters Regarding Beneficial Ownership" regarding the Company's assumptions about beneficial ownership and the presence of certain restrictions on the voting and disposition of the common shares beneficially owned by Messrs. M.J. Moroun, Harned, Lech, Agnes A. Moroun and Matthew T. Moroun. (4) Brinson Partners, Inc. ("BPI"), an SEC registered investment advisor, is a wholly owned subsidiary of Brinson Holdings, Inc. ("BHI"). BHI is a wholly owned subsidiary of SBC Holding (USA), Inc. which in turn is a wholly owned subsidiary of Swiss Bank Corporation. The total shares owned by BPI represent 9.6% of the Company's outstanding voting common shares. See Note (2) above. All of these common shares are held for the benefit of clients of BPI. No BPI client holds more than 5% of the outstanding voting common shares of the Company. The business address of Mr. LaGere is 1010 Manvel Avenue, Chandler, Oklahoma 74834. The business address for Mr. Walkingstick is 1001 Manvel Avenue, Chandler, Oklahoma 74834. The business address of CenTra, Can-Am, and Messrs. M.J. Moroun and Harned is 12225 Stephens Road, Warren, Michigan 48089. The business address of Mr. Lech is 5301 Lauren Court, Bloomfield Hills, Michigan 48302-2941.
PAGE 35 OTHER MATTERS REGARDING BENEFICIAL OWNERSHIP For purposes of this report, unless otherwise indicated, the Company has assumed that the following persons are affiliates: an entity's executive officers and directors or its managing partners, persons holding more than 10% of an entity, and those persons who are controlling, controlled by, or under common control with such officers, directors, managing partners, or shareholders. Statements of percentages of ownership are made based upon pertinent reporting requirements and guidelines specifically applicable to this report on Form 10-K. Determination of voting power under the Company's Articles of Association or applicable insurance holding company laws may be at variance with the above stated percentages. As to the beneficial ownership of its common shares, the Company has assumed that beneficial ownership (voting and investment power) is shared among CenTra, Can-Am, Ammex, and Messrs. M.J. Moroun, Harned, Lech, Agnes A. Moroun and Matthew T. Moroun. CenTra, Can-Am, Ammex and M.J. Moroun have filed a Schedule 13D acknowledging that they compose a group formed to affect the management practices and policies of the Company. M.J. Moroun has represented that he is the controlling shareholder, Chairman and President of CenTra and Ammex. Mr. Lech was, until June 2, 1995, a director and executive officer of CenTra and continues to receive regular periodic payments from CenTra. Mr. Harned is an executive officer of CenTra. Messrs. Harned and Lech are executive officers and directors of Can-Am. Correspondence provided to the Company and an amendment to the Schedule 13D described above indicate that M.J. Moroun is the owner of all of the outstanding voting stock of Can-Am. The Company includes the ownership of Messrs. Harned, Lech, Agnes A. Moroun and Matthew T. Moroun in the beneficial ownership of the CenTra Group because of their present or former employment and other relationships with CenTra and M.J. Moroun and their involvement in CenTra's attempts to take control of the Company. Each member of the group disclaims beneficial ownership or control of the common shares held by any other group member. They presumably would disclaim shared beneficial ownership with either Messrs. Harned or Lech. CenTra and its affiliates face certain restrictions in the voting or disposition of their common shares. By resolution dated August 19, 1992, the Company restricted the voting of common shares held by CenTra and its affiliates, including Can-Am. In addition, voting of these shares in a manner which would constitute a direct or indirect exercise of control over NAICO is restricted by Nebraska law. The Nebraska Department of Insurance has prohibited the disposition of the common shares held by Can-Am and the United States District Court for the District of Nebraska has assumed jurisdiction over all shares owned or controlled by M.J. Moroun and/or his affiliates. These shares have now been tendered to and are held by the U.S. District Court Clerk for the District of Nebraska. See "LEGAL PROCEEDINGS". POSSIBLE CHANGE IN CONTROL Until July 1992, CenTra and its affiliates held 22.7% of the Company's common shares. In July 1992, M.J. Moroun attempted to obtain control of the Company and acquired or contracted to acquire in open market and private purchases 26.5% of the Company's common stock (which was later transferred to Can-Am), bringing the total beneficial stock ownership of CenTra and its affiliates to 49.2% as of July 1992. To further their purposes, CenTra or its affiliates or both initiated litigation in Oklahoma, Arkansas, Michigan, and an administrative proceeding in Nebraska, the domicile of NAICO. See "LEGAL PROCEEDINGS" and "BUSINESS--Taxation--United States Taxation of Shareholders". To rebuff the threats posed by CenTra and its affiliates, the Company and its subsidiaries have vigorously asserted defenses and counterclaims where appropriate in the litigation and successfully opposed the Form A application of CenTra and its affiliates in the administrative hearings before the Nebraska Department of Insurance (the "Department"). The Form A application sought the Department's approval of M.J. Moroun's share purchases and attempted assertion of control. CenTra and its affiliates appealed the Department's denial of their application. The ruling of the Department and a state district court were affirmed by the Nebraska Supreme Court on December 1, 1995. The Department has prohibited the disposition of the common shares beneficially owned by Can-Am (the 26.5%). By resolution dated August 19, 1992, the Company has restricted the voting of common shares held by CenTra and its affiliates including Can-Am. The resolution invoked the provisions of Article XI of the Company's Articles of Association. Article XI, which was adopted by the shareholders in 1988, prohibits business combinations lacking approval of the Continuing Directors (those not affiliated with a 20% or more shareholder) or 80% of the shareholders and may result in a prohibition against voting such shares held by a shareholder acquiring 20% or more of the common shares (and its affiliates and associates) if the Continuing Directors deny approval. A U.S. District Court Judge for the District of Nebraska has ordered the divestiture of all CenTra shares and CenTra has delivered what it contends are all the shares they own or control to the registry of the Court, pending the appeal of the Court's divestiture order. The case is scheduled for oral argument before the Eighth Circuit Court of Appeals in April 1998. If the judgment is affirmed the Court will order a plan of divestiture. Until CenTra can overcome these impediments, it cannot take control of the Company. PAGE 36 Despite these impediments, CenTra continues its efforts to take control of the Company. See "CENTRA LITIGATION--Nebraska". While the Company believes it has good defenses to CenTra's threats, the possibility exists that CenTra could ultimately prevail, could defeat the corporate resolution, and could otherwise overcome the impediments (whether present or future) to its control. In its Schedule 13D, CenTra asserted that if it had control it would take steps such as reducing the number of directors, hiring a consultant to review NAICO's operations, and increasing the internal audit staff. Based on the Company's experience with CenTra in the CenTra insurance program and the findings of the Nebraska Department of Insurance, the state district court and the Nebraska Supreme Court and knowledge of CenTra's practices following other takeovers, the Company firmly believes that CenTra's control would pose far greater threats to the Company's shareholders and NAICO's policyholders than those reflected in CenTra's Schedule 13D. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS One of the Company's U.S. subsidiaries leases a rural property from Davenport Farms, Inc. ("Davenport Farms"), a corporation owned by Messrs. Brent LaGere, Richard Evans, Mark Paden and another employee of one of the Company's subsidiaries. The subsidiary has placed three mobile homes on the property, drilled a water well connected to the mobile homes and made other smaller improvements to the property. Its personnel maintains these improvements. These mobile homes and the property provide hunting, fishing, lodging, dining and other outdoor recreational activities for the entertainment of customers and business associates of Chandler USA and/or its subsidiaries. The subsidiary pays no rent to Davenport Farms but reimburses it for one-half of the utilities and for hunting supplies. The subsidiary has also agreed to indemnify Davenport Farms for claims arising out of its use of the property. The subsidiary retains the right to remove all structures located upon the property when the lease terminates. In 1995, 1996 and 1997, the Company incurred approximately $108,000, $184,000 and $159,000 in entertainment expenses in connection with the use of Davenport Farms including approximately $14,000, $7,000 and $5,000 in depreciation, and reimbursements (described above) to Davenport Farms of approximately $8,000, $8,000 and $9,000 in each of those years. On September 18, 1997, Mr. Walkingstick and L&W entered into an agreement providing that Mr. Walkingstick will produce insurance business only through L&W as an independent contractor (the "Insurance Agreement"). Mr. Walkingstick will receive one-half of all commissions upon any business he produces which was not previously written by L&W and is liable for payment of all premiums due upon such business. The Insurance Agreement may be terminated at any time upon thirty days written notice. Upon termination, the insurance policy expirations or renewal rights (ownership) of the insurance business produced by Mr. Walkingstick shall remain the property of L&W. Mr. Walkingstick is required to maintain his own support staff. During 1997, commissions paid to Mr. Walkingstick under this arrangement were $10,832. The Company's U.S. subsidiaries lease automobiles from Union National Bank ("UNB") of which Mr. Benjamin Walkingstick is Chairman. In 1996 and 1997, UNB received automobile lease payments of $120,000 and $128,000, and automobile purchase payments of $53,000 and $56,000. UNB received $8,000 and $10,000 as reimbursement for automobile tags, titles and taxes in connection with such automobile leases in 1996 and 1997, respectively. The Company's U.S. subsidiaries also use UNB as their principal disbursement bank. They pay no service charges for such services but are required to maintain compensating balances in lieu of paying service charges. The average daily amount of the compensating balances in the aggregate was approximately $300,000 during 1997. The balance maintained by each subsidiary is fully insured by the Federal Deposit Insurance Corporation. The Company believes that all transactions, including loans, with directors, officers, or shareholders of the Company are and will continue to be on terms no less favorable to the Company than could be obtained from unaffiliated parties. ADVANCEMENT OF LITIGATION EXPENSES. In the CenTra litigation, certain officers of the Company and the Company's directors other than Messrs. M.J. Moroun, Harned, Lech and Maestri were named as defendants. In accordance with its Articles of Association, the Company has advanced the litigation expenses of these persons in exchange for undertakings to repay such expenses if those persons are later determined to have breached the standard of conduct provided in the Articles of Association. The Company has paid expenses totaling approximately $2.1 million as of December 31, 1997. A portion of these expenses relate to claims which have been dismissed or which were decided in favor of the officers and directors. In addition, certain expenses may be recovered from the Company's directors and officers policy insurer. As a result of various events in 1995, the Company recorded an $818,000 estimated recovery of costs from its directors and officers policy insurer related to a $1 million claim for reimbursable amounts previously paid that relate to allowable defense and litigation costs for such parties. In 1996, the Company recorded an additional estimated recovery of $982,000. The Company received a payment for the 1995 claim during 1996 in the amount of $795,000. In connection with the Oklahoma Federal Court judgments, the Company recorded an additional estimated recovery of $2.7 million from the Company's directors and officers policy insurer. The Company is entitled to a total of $5 million under the applicable insurance policy. Some amounts have been previously paid without dispute and the Company is negotiating with the insurer for payment of the policy balance. The Company could recover the remaining policy limits or could compromise its claim, and could incur significant costs in either case. The estimated insurance recovery is based upon these variable factors. Except for the recovery of a portion of the litigation costs from the Company's directors and officers policy insurer, no provision has been made in the accompanying consolidated financial statements related to the advancement of litigation expenses to certain defendants. The Committee was delegated the authority of the Board to deal with all issues arising from the Oklahoma litigation including the issue of officer and director indemnification. The Committee has retained independent counsel. PAGE 37 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) 1. FINANCIAL STATEMENTS. The consolidated balance sheets of the Company and its subsidiaries as of December 31, 1996 and 1997, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997, together with the related notes thereto and the report of Deloitte & Touche, independent auditors on such financial statements as of December 31, 1997 and for the three years then ended are filed as a part of this Form 10-K. See accompanying Index on page F-1. 2. FINANCIAL STATEMENT SCHEDULES. The financial statement schedules listed in the accompanying index to consolidated financial statements and schedules are filed as part of this Form 10-K. All other schedules have been omitted since the required information is not applicable or is not present in amounts sufficient to require submission of the schedule or because the information is included in the consolidated financial statements or the notes thereon. 3. EXHIBITS. 3.1 Memorandum of Association of the Company. (2) 3.2 Articles of Association of the Company and amendments thereto. (2)(1) 4.1 Specimen Certificate for common shares of the Company. (4) 10.1Non-Qualified Stock Option Plan, as amended, adopted at the Shareholder's Annual Meeting on January 19, 1987. (3) 10.2 Form of Non-Qualified Stock Option Agreement. (1) 10.3 Agreement for Placement of Insurance Business. (5) 22.1 List of all subsidiaries. 23.1 Deloitte & Touche consent. ----------------------- (1) Previously filed as an exhibit to Registration No. 33-21381 on Form S-1 and incorporated herein by reference. (2) Previously filed as an exhibit to Registration No. 33-5168 on Form S-1 and incorporated herein by reference. (3) Previously filed as an exhibit to registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1987 and incorporated herein by reference. (4) Previously filed as an exhibit to Registration No. 33-33540 on Form S-2 and incorporated herein by reference. (5) Previously filed as an exhibit to registrant's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1997 and incorporated herein by reference. Copies of the foregoing exhibits filed with this Form 10-K or incorporated by reference are available from the Company upon written request and payment of a reasonable copying fee. (b) Reports on Form 8-K. The Company filed one current report on Form 8-K dated March 17, 1998 responding to Item 5 of Form 8-K. PAGE 38 SIGNATURES PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED. CHANDLER INSURANCE COMPANY, LTD. Date: March 30, 1998 By: /s/ W. Brent LaGere - ---------------------------------------- W. Brent LaGere Chairman of the Board, President, and Chief Executive Officer PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATE INDICATED. Date: March 30, 1998 /s/ W. Brent LaGere - ---------------------------------------- W. Brent LaGere, Chairman of the Board, Chief Executive Officer, President and Director (Principal Executive Officer) Date: March 30, 1998 /s/ Brenda B. Watson - ---------------------------------------- Brenda B. Watson, Executive Vice President and Director Date: March 30, 1998 /s/ Mark T. Paden - ---------------------------------------- Mark T. Paden, Vice President - Finance, Chief Financial Officer, Treasurer and Director (Principal Accounting and Financial Officer) Date: March 30, 1998 /s/ Richard L. Evans - ---------------------------------------- Richard L. Evans, Vice President - Claims and Director PAGE 39 Date: March 30, 1998 /s/ James M. Jacoby - ---------------------------------------- James M. Jacoby, Director Date: March 30, 1998 /s/ Robert L. Rice - ---------------------------------------- Robert L. Rice, Director Date: March 30, 1998 /s/ Paul A. Maestri - ---------------------------------------- Paul A. Maestri, Director Date: - ---------------------------------------- M.J. Moroun, Director Date: - ---------------------------------------- Norman E. Harned, Director Date: - ---------------------------------------- Ronald W. Lech, Director Date: March 30, 1998 /s/ Larry A. Davis - ---------------------------------------- Larry A. Davis, Director PAGE F-1 CHANDLER INSURANCE COMPANY, LTD. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES PAGES - ----------------- FINANCIAL STATEMENTS Consolidated Balance Sheets as of December 31, 1996 and 1997............................... F-2 Consolidated Statements of Operations for the years ended December 31, 1995, 1996 and 1997......................... F-3 Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1996 and 1997......................... F-4 Consolidated Statements of Shareholders' Equity for the years ended December 31, 1995, 1996 and 1997............. F-5 Notes to Consolidated Financial Statements.................... F-6 through F-26 Independent Auditors' Report on Consolidated Financial Statements and Financial Statement Schedules............. F-27 SCHEDULES I Summary of Investments - Other than Investments in Related Parties.................................. F-28 II Condensed Financial Information of Registrant............F-29 through F-31 III Supplementary Insurance Information...................... F-32 IV Reinsurance.............................................. F-33 V Valuation and Qualifying Accounts........................ F-34 VI Supplemental Information (for property-casualty insurance underwriters)............................. F-35 Schedules other than those listed above are omitted since the required information is not applicable or because the information is included in the consolidated financial statements or the notes thereon. PAGE F-2 CHANDLER INSURANCE COMPANY, LTD. CONSOLIDATED BALANCE SHEETS (Dollars in thousands except per share amounts)
DECEMBER 31, - ----------------------- 1996 1997 ---------- - ---------- ASSETS Investments Fixed maturities available for sale, at fair value......................................$ 109,665 $ 111,718 Fixed maturities held to maturity, at amortized cost (fair value $1,675 and $1,330 in 1996 and 1997, respectively)....................... 1,582 1,222 Equity securities available for sale, at fair value...................................... - 124 ---------- - ---------- Total investments.................................. 111,247 113,064 Cash and cash equivalents................................ 7,889 11,999 Premiums receivable, less allowance for non-collection of $177 and $115 at 1996 and 1997, respectively....... 30,413 28,079 Reinsurance recoverable on paid losses, less allowance for non-collection of $491 and $275 in 1996 and 1997, respectively................................ 3,805 3,069 Reinsurance recoverable on unpaid losses, less allowance for non-collection of $390 at 1997.................... 14,432 10,876 Prepaid reinsurance premiums............................. 5,470 9,662 Deferred policy acquisition costs........................ 4,993 5,312 Property and equipment, net.............................. 5,934 5,907 Other assets............................................. 11,517 12,893 Licenses, net............................................ 4,494 4,344 Excess of cost over net assets acquired, net............. 5,900 5,252 Covenants not to compete, net............................ 733 333 ---------- - ---------- Total assets.............................................$ 206,827 $ 210,790 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities Unpaid losses and loss adjustment expenses............$ 79,639 $ 74,929 Unearned premiums..................................... 36,009 42,388 Policyholder deposits.............................. 4,016 4,830 Notes payable...................................... 4,391 2,796 Accrued taxes and other payables................... 7,777 6,340 Premiums payable................................... 2,448 4,554 Litigation liabilities............................. - 16,618 ---------- - ---------- Total liabilities............................... 134,280 152,455 ---------- - ---------- Commitments and contingencies (Notes 10 and 11) Shareholders' equity Common stock, $1.67 par value, 10,000,000 shares authorized; 6,941,708 shares issued................ 11,593 11,593 Paid-in surplus....................................... 34,942 34,942 Capital redemption reserve............................ 947 947 Retained earnings..................................... 25,951 24,886 Unrealized gain (loss) on investments available for sale, net of tax............................... (886) 253 Less: Stock held by subsidiary, at cost (494,617 shares)................................... - (2,487) Less: Stock rescinded through litigation (1,660,125 shares)................................. - (11,799) ---------- - ---------- Total shareholders' equity............................... 72,547 58,335 ---------- - ---------- Total liabilities and shareholders' equity...............$ 206,827 $ 210,790 ========== ==========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. PAGE F-3 CHANDLER INSURANCE COMPANY, LTD. CONSOLIDATED STATEMENTS OF OPERATIONS (Amounts in thousands except per share data)
YEAR ENDED DECEMBER 31, - ------------------------------------ 1995 1996 1997 ---------- ---------- - ---------- Premiums and other revenues Direct premiums written and assumed......$ 98,768 $ 107,943 $ 123,088 Reinsurance premiums ceded............... (14,128) (14,228) (26,222) ---------- ---------- - ---------- Net premiums written and assumed...... 84,640 93,715 96,866 Increase in unearned premiums............ (3,553) (4,429) (2,187) ---------- ---------- - ---------- Net premiums earned................... 81,087 89,286 94,679 Net investment income....................... 8,053 7,339 8,017 Commissions, fees and other income.......... 3,095 3,620 2,528 ---------- ---------- - ---------- Total revenues........................ 92,235 100,245 105,224 ---------- ---------- - ---------- Operating costs and expenses Losses and loss adjustment expenses...... 50,543 53,391 57,512 Policy acquisition costs................. 23,995 32,123 28,145 General and administrative expenses...... 12,822 14,184 13,579 Litigation expenses, net................. 285 (108) 4,772 ---------- ---------- - ---------- Total operating expenses.............. 87,645 99,590 104,008 ---------- ---------- - ---------- Income before income taxes.................. 4,590 655 1,216 Federal income tax (provision) benefit of consolidated U.S. subsidiaries........ (812) 317 (2,281) ---------- ---------- - ---------- Net income (loss)...........................$ 3,778 $ 972 $ (1,065) ========== ========== ========== Basic and diluted earnings (loss) per common share.........................$ 0.54 $ 0.14 $ (0.16) ========== ========== ========== Weighted average common shares outstanding.. 6,942 6,942 6,687 ========== ========== ==========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. PAGE F-4 CHANDLER INSURANCE COMPANY, LTD. CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands)
YEAR ENDED DECEMBER 31, ------------------------------------ 1995 1996 1997 ---------- ---------- - ---------- OPERATING ACTIVITIES: Net income (loss)........................$ 3,778 $ 972 $ (1,065) Add (deduct): Adjustments to reconcile net income (loss) to cash from operations: Net realized gains on sale of investments.................. (412) (140) (764) Net (gains) losses on sale of equipment.................... 1 (23) 3 Amortization and depreciation...... 2,313 2,292 2,214 Provision for non-collection of premiums..................... 124 1,768 52 Provision for non-collection of reinsurance recoverables..... 440 2,078 527 Net change in non-cash balances relating to operations: Premiums receivable................ (1,575) 2,877 (1,794) Reinsurance recoverable on paid losses..................... (1,388) (1,250) 596 Reinsurance recoverable on unpaid losses................... 10,691 32,197 3,169 Prepaid reinsurance premiums....... (581) (300) (4,192) Deferred policy acquisition costs.. 205 (1,193) (319) Other assets....................... 1,692 (253) (2,456) Unpaid losses and loss adjustment expenses............. (27,266) (49,155) (4,710) Unearned premiums.................. 4,133 4,729 6,379 Policyholder deposits.............. (1,079) (468) 814 Accrued taxes and other payables... 861 2,108 (1,437) Premiums payable................... (1,421) (524) 2,106 Litigation liabilities............. - - 4,819 ---------- ---------- - ---------- Cash provided by (applied to) operations......................... (9,484) (4,285) 3,942 ---------- ---------- - ---------- INVESTING ACTIVITIES: Fixed maturities available for sale: Purchases............................. (32,449) (34,085) (35,001) Sales................................. 9,364 16,880 22,232 Maturities............................ 15,849 12,967 12,541 Fixed maturities held to maturity: Purchases............................. (35) - - - Maturities............................ 17,736 4,409 380 Equity securities available for sale: Sale.................................. - - 2,459 Cost of property and equipment purchased............................. (802) (687) (893) Proceeds from sale of property and equipment............................. 141 95 45 Other.................................... (216) (20) - - ---------- ---------- - ---------- Cash provided by (applied to) investing activities............... 9,588 (441) 1,763 ---------- ---------- - ---------- FINANCING ACTIVITIES: Proceeds from notes payable.............. - 4,500 - - Payments on notes payable................ - (409) (1,595) ---------- ---------- - ---------- Cash provided by (applied to) financing activities.................. - 4,091 (1,595) ---------- ---------- - ---------- Increase (decrease) in cash and cash equivalents.............................. 104 (635) 4,110 Cash and cash equivalents at beginning of year.................................. 8,420 8,524 7,889 ---------- ---------- - ---------- Cash and cash equivalents at end of year....$ 8,524 $ 7,889 $ 11,999 ========== ========== ==========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. PAGE F-5 CHANDLER INSURANCE COMPANY, LTD. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (Dollars in thousands)
UNREALIZED GAIN STOCK TOTAL CAPITAL (LOSS) ON STOCK RESCINDED SHARE- COMMON PAID-IN REDEMPTION RETAINED INVESTMENTS, HELD BY THROUGH HOLDERS' STOCK SURPLUS RESERVE EARNINGS NET SUBSIDIARY LITIGATION EQUITY ------------ ------------ ------------ ------------ - ------------ ------------ ------------ ------------ Balance, January 1, 1995........$ 12,540 $ 36,143 $ - $ 22,148 $ (5,224) $ (2,148) $ - $ 63,459 Net income................ - - - 3,778 - - - 3,778 Change in unrealized gain (loss) on investments available for sale, net of tax............. - - - - - 6,213 - - 6,213 ------------ ------------ ------------ ------------ - ------------ ------------ ------------ ------------ Balance, December 31, 1995...... 12,540 36,143 - 25,926 989 (2,148) - 73,450 Net income................ - - - 972 - - - 972 Retirement of stock held by subsidiary..... (947) (1,201) 947 (947) - 2,148 - - Change in unrealized gain (loss) on investments available for sale, net of tax............. - - - - - (1,875) - - (1,875) ------------ ------------ ------------ ------------ - ------------ ------------ ------------ ------------ Balance, December 31, 1996...... 11,593 34,942 947 25,951 (886) - - 72,547 Net loss.................. - - - (1,065) - - - (1,065) Stock acquired by subsidiary, at cost (494,617 shares)....... - - - - - - (2,487) - (2,487) Stock rescinded through litigation (1,660,125 shares)................ - - - - - - - (11,799) (11,799) Change in unrealized gain (loss) on investments available for sale, net of tax............. - - - - - 1,139 - - 1,139 ------------ ------------ ------------ ------------ - ------------ ------------ ------------ ------------ Balance, December 31, 1997......$ 11,593 $ 34,942 $ 947 $ 24,886 $ 253 $ (2,487) $ (11,799) $ 58,335 ============ ============ ============ ============ ============ ============ ============ ============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. PAGE F-6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1995, 1996 AND 1997 NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES (A) BASIS OF PRESENTATION Chandler Insurance Company, Ltd. ("Chandler" or the "Company") is a holding company organized and domiciled in the Cayman Islands. The Company's wholly owned subsidiaries are engaged in various property and casualty insurance and reinsurance operations. The property and casualty insurance coverage is primarily for businesses in various industries, political subdivisions, nonstandard private-passenger automobiles and surety bonds for small contractors in the United States of America ("U.S."). One of the subsidiaries principally reinsures risks underwritten by another subsidiary. In addition, one of the subsidiaries operates as an independent insurance agency based in Chandler, Oklahoma, which represents various insurance companies that provide a variety of property-casualty, life and accident and health coverages, and acts as a surplus lines broker specializing in risk management and brokering insurance for high risk ventures. Operating revenues, expenses and identifiable assets are primarily from operations outside the Cayman Islands. A substantial part of the business is conducted through individual independent insurance agencies and underwriting managers, primarily in the Southwest and Midwest areas of the U.S. The consolidated financial statements have been prepared in accordance with United States of America generally accepted accounting principles ("U.S. GAAP") and are expressed in U.S. dollars. The preparation of the financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates. (B) PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and all subsidiaries. The following represents the significant subsidiaries: > Chandler Insurance (Barbados), Ltd. ("Chandler Barbados") and NAICO Indemnity (Cayman), Ltd. ("NAICO Indemnity"), wholly owned subsidiaries of the Company. > Chandler (U.S.A.), Inc. ("Chandler USA"), a wholly owned subsidiary of Chandler Barbados. > National American Insurance Company ("NAICO"), LaGere and Walkingstick Insurance Agency, Inc. ("L&W") and Network Administrators, Inc. ("Network"), wholly owned subsidiaries of Chandler USA. All significant intercompany accounts and transactions have been eliminated in consolidation. (C) REVENUE RECOGNITION Premiums are generally recognized as earned on a pro rata basis over the policy period. Commission revenues are generally recognized when coverage is effective and premiums are billed. (D) UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES Losses and loss adjustment expenses are charged to income as incurred. The reserve for unpaid losses and loss adjustment expenses represents the accumulation of estimates for reported losses and includes provisions for losses incurred but not reported based on data available at this time. The methods of determining such estimates and establishing resulting reserves are continually reviewed and updated, and adjustments therefrom are necessary to maintain an adequate reserve for unpaid claims. As more fully explained in Note 3, such estimates are management's best estimates of the expected values. The actual results may vary from these values since the evaluation of losses is inherently subjective and susceptible to significant changing factors. PAGE F-7 (E) BASIC AND DILUTED EARNINGS (LOSS) PER COMMON SHARE The Company has adopted Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 128, EARNINGS PER SHARE. Basic earnings (loss) per common share is computed based upon net income (loss) divided by the weighted average number of common shares outstanding during each period. The Company does not have any preferred stock or dilutive potential common shares; as such, diluted earnings (loss) per common share is not applicable. The adoption of SFAS No. 128 did not affect the previously reported earnings per share for all periods presented. (F) DEFERRED POLICY ACQUISITION COSTS Policy acquisition costs that vary with and are primarily related to the acquisition of new and renewal business (such as premium taxes, agents' commissions and a portion of other underwriting expenses) are deferred and amortized over the terms of the policies. Recoverability of such deferred costs is dependent on the related unearned premiums on the policies being more than expected claim losses. The Company considers anticipated investment income in determining if a premium deficiency exists. Certain policy acquisition costs, such as policyholder dividends, are expensed directly. NAICO paid or accrued $434,000, $454,000 and $1.2 million during 1995, 1996 and 1997, respectively, for dividends to policyholders primarily on participating workers compensation policies. Gross written premiums for participating policies were $6.2 million, $3.2 million and $2.9 million in 1995, 1996 and 1997, respectively. (G) PROPERTY AND EQUIPMENT Real estate and improvements and other property and equipment are stated at cost and depreciated using the straight-line method over their useful lives which range from 3 years to 31 years. Asset impairments are recorded when events or changes in circumstances indicate that the carrying amount of assets may not be recoverable. Property and equipment consisted of the following at December 31:
1996 1997 ---------- - ---------- (In thousands) Real estate and improvements..........................$ 5,351 $ 5,389 Other property and equipment.......................... 7,575 7,738 ---------- - ---------- 12,926 13,127 Accumulated depreciation.............................. (6,992) (7,220) ---------- - ---------- $ 5,934 $ 5,907 ========== ==========
(H) INTANGIBLE ASSETS The cost of insurance licenses acquired is amortized over 40 years using the straight-line method. Covenants not to compete are amortized by the straight-line method over 10 years. The excess of cost over net assets acquired is amortized by the straight-line method over 15-17 years. Excess of cost over fair value of net assets acquired is written down if it is probable that estimated undiscounted operating income generated by the related assets will be less than the carrying amount. Intangible assets included the following at December 31:
1996 1997 ---------- ---------- (In thousands) Licenses..............................................$ 5,991 $ 5,991 Excess of cost over net assets acquired............... 10,748 10,748 Covenants not to compete.............................. 4,000 4,000 ---------- - ---------- 20,739 20,739 Accumulated amortization.............................. (9,612) (10,810) ---------- - ---------- $ 11,127 $ 9,929 ========== ==========
PAGE F-8 (I) POLICYHOLDER DEPOSITS NAICO requires certain policyholders to pay a deposit at inception of coverage to secure payment of future premiums and deductibles on claims incurred. It is expressly agreed between NAICO and the policyholder that the funds will be used by NAICO only in the event the policyholder fails to pay any premiums or deductibles when due. NAICO has established a liability for these deposits in an amount equal to that due the policyholders based on insurance premiums reported as of the balance sheet date. (J) INVESTMENTS At the time of purchase, investments in debt securities that the Company has the positive intent and ability to hold to maturity are classified as held to maturity and reported at amortized cost; all other debt securities are reported at fair value. Investments classified as trading are actively and frequently bought and sold with the objective of generating income on short-term differences in price. Realized and unrealized gains and losses on securities classified as trading account assets are recognized in current operations. The Company has not classified any investments as trading account assets. Securities not classified as held to maturity or trading are classified as available for sale, with the related unrealized gains and losses excluded from earnings and reported net of tax as a separate component of shareholders' equity until realized. Realized gains and losses on sales of securities are based on the specific identification method and included in net investment income in the accompanying consolidated statements of operations. (K) INCOME TAXES The Company uses an asset and liability approach for accounting for income taxes. Deferred income taxes are recognized for the tax consequences of temporary differences and carryforwards by applying enacted tax rates applicable to future years to differences between the financial statement amounts and the tax bases of existing assets and liabilities. A valuation allowance is established if it is more likely than not that some portion of the deferred tax asset will not be realized. (L) CASH AND CASH EQUIVALENTS For purposes of the consolidated statements of cash flows, the Company considers all highly liquid investments with original maturities of 14 days or less to be cash equivalents. For cash and cash equivalents, the carrying amount is a reasonable estimate of fair value. (M) SUPPLEMENTAL CASH FLOW INFORMATION Cash payments for interest and income taxes, and noncash investing and financing activities were as follows:
YEAR ENDED DECEMBER 31, - ------------------------------ 1995 1996 1997 -------- - -------- -------- (In thousands) Cash payments during the year for: Interest....................................$ 8 $ 141 $ 818 Income taxes................................ 864 574 1,855 Change in unrealized gain (loss) on securities available for sale...............$ 8,224 $ (2,522) $ 1,605 Provision (benefit) for federal income taxes..... 2,011 (647) 466 -------- - -------- -------- Net increase (decrease) in shareholders' equity..$ 6,213 $(1,875) $ 1,139
As allowed by authoritative accounting literature, during the period November 15 to December 31, 1995, the Company made a one-time reclassification of $5,442,000 of investment securities from held to maturity to available for sale. The fair value of such securities at the date of transfer was $5,737,000 and the unrealized gain was $295,000. Subsequent to the reclassification but prior to December 31, 1995, the Company sold a portion of such securities having a fair value of $5,393,000 and realized a gain of $256,000. In the 1995 acquisition of Network, the Company acquired assets with a fair value of $686,000 which included $84,000 of cash and $524,000 of goodwill associated with the acquisition. In addition, the Company assumed or created liabilities of $386,000 which included a $300,000 note payable issued in connection with the acquisition. The acquisition resulted in a net cash outflow to the Company of $236,000. PAGE F-9 In January 1997, NAICO received Century Business Services, Inc. common stock (formerly International Alliance Services, Inc.) valued at approximately $2.2 million at the settlement date as a result of settling certain legal disputes with a former underwriting manager for the surety bond program. This amount was included in premiums receivable at December 31, 1996. During 1997, NAICO received shares of common stock with a fair value of approximately $124,000 in connection with an unaffiliated entity's conversion to a for-profit corporation. See Note 2. During 1997, ownership of 494,617 shares of the Company's common stock was transferred to Chandler's subsidiaries as payment for certain debts owed by two former agents of the subsidiaries. The shares are held as a reduction of shareholders' equity in the amount of approximately $2.5 million. See Note 10 for additional information. As a result of a jury verdict in April 1997, the Company recorded the rescission of certain common stock that it sold in 1990 in return for a future payment of $5,099,133. The rescission was recorded as a decrease to shareholders' equity in the amount of approximately $4,916,000 with the remaining amount included in litigation expense. In the fourth quarter of 1997, the Company recorded the rescission of certain additional common stock pursuant to an order issued on March 10, 1998 in the amount of $6,882,500. The payable amounts are included in "Litigation Liabilities" on the Company's balance sheet as of December 31, 1997. See Note 10 for additional information. (N) REINSURANCE Management believes all of the Company's reinsurance contracts with reinsurers meet the criteria for risk transfer and the revenue and cost recognition provisions in order to be accounted for as reinsurance. As more fully explained in Note 11, reinsurance contracts do not relieve the Company from its obligation to policyholders. In addition, failure of reinsurers to honor their obligations could result in losses to the Company. (O) ACCOUNTING STANDARDS ISSUED BUT NOT YET ADOPTED In June 1997, the FASB issued SFAS No. 130, REPORTING COMPREHENSIVE INCOME, which establishes standards for reporting and displaying comprehensive income and its components (revenues, expenses, gains and losses) in financial statements. In addition, SFAS No. 130 requires the Company to classify items of other comprehensive income by their nature in a financial statement and display the accumulated balance of other comprehensive income separately in the shareholders' equity section of the consolidated balance sheets. The Company will adopt SFAS No. 130 on January 1, 1998 as required. Also in June 1997, the FASB issued SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION. SFAS No. 131 establishes reporting standards for public companies concerning annual and interim financial statements of their operating segments and related information. Operating segments are components of a company about which separate financial information is available that is regularly evaluated by the chief operating decision maker(s) in deciding how to allocate resources and assess performance. The Standard sets criteria for reporting disclosures about a company's products and services, geographic areas and major customers. The Company will adopt SFAS No. 131 on January 1, 1998 as required. NOTE 2. INVESTMENTS AND INVESTMENT INCOME Net investment income is summarized as follows:
YEAR ENDED DECEMBER 31, - ------------------------------ 1995 1996 1997 -------- -------- - -------- (In thousands) TYPE OF INVESTMENT: Interest on fixed-maturity investments...........$ 6,994 $ 6,663 $ 6,680 Interest on cash equivalents..................... 647 536 573 Net realized gains - fixed - maturity investments................................. 412 140 508 Net realized gains - equities.................... - - 256 -------- -------- - -------- $ 8,053 $ 7,339 $ 8,017 ======== ======== ========
These amounts are net of investment expenses, which are minimal. PAGE F-10 The amortized cost and fair values of investments are as follows:
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR CARRYING COST GAINS LOSSES VALUE VALUE - ---------- ---------- ---------- ---------- ---------- (In thousands) DECEMBER 31, 1996 - ----------------------------------------------------------------- FIXED MATURITIES AVAILABLE FOR SALE: U.S. Treasury securities and obligations of U.S. government corporations and agencies........................ $ 43,672 $ 295 $ (467) $ 43,500 $ 43,500 Debt securities issued by foreign governments.................... 2,488 42 (28) 2,502 2,502 Corporate obligations............................................ 43,973 141 (868) 43,246 43,246 Public utilities................................................. 15,039 78 (410) 14,707 14,707 Mortgage-backed securities....................................... 5,678 40 (8) 5,710 5,710 - ---------- ---------- ---------- ---------- ---------- $ 110,850 $ 596 $ (1,781) $ 109,665 $ 109,665 ========== ========== ========== ========== ========== FIXED MATURITIES HELD TO MATURITY: U.S. Treasury securities and obligations of U.S. government corporations and agencies........................ $ 1,547 $ 96 $ (3) $ 1,640 $ 1,547 Corporate obligations............................................ 35 - - 35 35 - ---------- ---------- ---------- ---------- ---------- $ 1,582 $ 96 $ (3) $ 1,675 $ 1,582 ========== ========== ========== ========== ========== DECEMBER 31, 1997 - ----------------------------------------------------------------- FIXED MATURITIES AVAILABLE FOR SALE: U.S. Treasury securities and obligations of U.S. government corporations and agencies........................ $ 41,208 $ 318 $ (136) $ 41,390 $ 41,390 Debt securities issued by foreign governments.................... 1,516 - (13) 1,503 1,503 Obligations of states and political subdivisions................. 20,365 167 (8) 20,524 20,524 Corporate obligations............................................ 35,836 108 (213) 35,731 35,731 Public utilities................................................. 9,048 86 (42) 9,092 9,092 Mortgage-backed securities....................................... 3,449 30 (1) 3,478 3,478 - ---------- ---------- ---------- ---------- ---------- $ 111,422 $ 709 $ (413) $ 111,718 $ 111,718 ========== ========== ========== ========== ========== FIXED MATURITIES HELD TO MATURITY: U.S. Treasury securities and obligations of U.S. government corporations and agencies........................ $ 1,222 $ 108 $ - $ 1,330 $ 1,222 ========== ========== ========== ========== ========== EQUITY SECURITIES AVAILABLE FOR SALE: Corporate stock.................................................. $ - - $ 124 $ - $ 124 $ 124 ========== ========== ========== ========== ==========
During 1997, NAICO received 19,371 shares of class B common stock of the Insurance Services Office, Inc. ("ISO") in connection with ISO's conversion to a for-profit corporation. ISO has placed certain limitations on the transfer or sale of the class B common stock one of which restricts ownership of the shares to insurance companies whose primary activity is the writing of insurance or the reinsuring of risk underwritten by insurance companies. PAGE F-11 The maturities of investments in fixed maturities at December 31, 1997 are shown below:
AVAILABLE FOR SALE HELD TO MATURITY ----------------------- - ----------------------- AMORTIZED AMORTIZED COST FAIR VALUE COST FAIR VALUE ---------- ---------- ---------- - ---------- (In thousands) Due in one year or less.....$ 19,461 $ 19,445 $ 100 $ 100 Due after one year through five years..... 37,247 37,275 267 266 Due after five years through ten years...... 45,254 45,451 855 964 Due after ten years......... 6,011 6,069 - - - ---------- ---------- ---------- - ---------- 107,973 108,240 1,222 1,330 Mortgage-backed securities, which are subject to prepayments............ 3,449 3,478 - - - ---------- ---------- ---------- - ---------- $ 111,422 $ 111,718 $ 1,222 $ 1,330 ========== ========== ========== ==========
Realized gains and losses from sales of fixed maturities and equity securities are shown below:
GROSS GROSS REALIZED REALIZED GAINS LOSSES ---------- - ---------- (In thousands) 1995..................................................$ 419 $ 7 1996.................................................. 178 38 1997.................................................. 803 39
Chandler Barbados is required as a foreign reinsurer to secure reserves for unpaid losses and loss adjustment expenses and unearned premiums for the benefit of the primary insurer ceding such amounts. Chandler Barbados secures such amounts with trust arrangements whereby securities are deposited into a trust account for the benefit of the primary insurer, and by using irrevocable bank letters of credit which are secured by certificates of deposit and other fixed-income investments. At December 31, 1996 and 1997, Chandler Barbados had investments with a fair value of $19,373,000 and $16,682,000, respectively, deposited in a trust account for the benefit of NAICO. NAICO is required by several states to deposit securities with state regulators as a condition of doing business in those states. As of December 31, 1996 and 1997, the carrying value of these deposits totaled $10,318,000 and $8,246,000, respectively. NAICO is also required to deposit securities into a trust account related to reinsurance agreements. As of December 31, 1996 and 1997, the fair value of these deposits totaled $211,000 and $212,000, respectively. At December 31, 1997 the total amount of cash and investments restricted as a result of these arrangements was $25,140,000. NOTE 3. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES The Company provides a reserve for estimated losses (reported and unreported) and loss adjustment expenses based on historical experience and payment reporting patterns for the type of risk involved. These estimates are based on data available at the time of the estimate and such estimates are periodically reviewed by independent professional actuaries. Inherent in the estimates of the ultimate liability for unpaid claims are expected trends in claim severity, claim frequency and other factors that may vary as claims are settled. The amount and uncertainty in the estimates are affected by such factors as the amount of historical claims experience relative to the development period for the type of risk, knowledge of the actual facts and circumstances, and the amount of insurance risk retained. The ultimate cost of insurance claims can be adversely affected by increased costs such as medical, repair expenses, costs of providing legal defense for policyholders, increased jury awards, and court decisions and legislation that define and expand insurance coverage subsequent to the time that the insurance policy was priced and sold. Salvage and subrogation recoverables are accrued using the "case basis" method for large recoverables and statistical estimates based on historical experience for smaller recoverables. Recoverable amounts deducted from the Company's net liability for losses and loss adjustment expenses were approximately $3,615,000 and $3,809,000 at December 31, 1996 and 1997, respectively. Although such estimates are management's best estimates of the expected values, the ultimate liability for unpaid claims may vary from these values. The Company does not discount the liability for unpaid losses and loss adjustment expenses. PAGE F-12 The following table sets forth a reconciliation of the beginning and ending unpaid losses and loss adjustment expenses which are net of reinsurance deductions.
YEAR ENDED DECEMBER 31, - ------------------------------------ 1995 1996 1997 ---------- ---------- - ---------- (In thousands) Net balance before provision for uncollectible reinsurance at beginning of year.......................$ 97,894 $ 81,388 $ 64,430 ---------- ---------- - ---------- Net losses and loss adjustment expenses incurred related to: Current year............................ 50,975 53,314 53,704 Prior years............................. (432) 77 3,808 ---------- ---------- - ---------- Total................................ 50,543 53,391 57,512 ---------- ---------- - ---------- Net paid losses and loss adjustment expenses related to: Current year............................ (21,106) (23,836) (22,214) Prior years............................. (45,943) (46,513) (36,838) ---------- ---------- - ---------- Total................................ (67,049) (70,349) (59,052) ---------- ---------- - ---------- Net balance before provision for uncollectible reinsurance............... 81,388 64,430 62,890 Adjustments to reinsurance recoverables on unpaid losses for uncollectible reinsurance............................. 629 777 1,163 ---------- ---------- - ---------- Net balance at end of year.................$ 82,017 $ 65,207 $ 64,053 ========== ========== ==========
NAICO does not ordinarily insure against environmental matters as that term is commonly used. However, in some cases, regulatory filings made on behalf of an insured can make NAICO directly liable to the regulatory authority for property damage which could include environmental pollution. In those cases NAICO ordinarily has recourse against the insured or the surety bond principal for amounts paid. NAICO has insured certain trucking companies and pest control operators who are required to provide proof of insurance which in some cases assures payment for clean-up and restoration of damage resulting from sudden and accidental release or discharge of contaminants or other substances which may be classified as pollutants. NAICO also provides surety bonds for construction contractors who use or have control of such substances and for contractors who remove and dispose of asbestos as a part of their contractual obligations. NAICO also insures independent oil and gas producers who may purchase coverage for the escape of oil, saltwater, or other substances which may be harmful to persons or property, but may not generally be classified as pollutants. Chandler Barbados reinsures a portion of those risks. The Company maintains claims records which segregate this type of risk for the purpose of evaluating environmental risk exposure. Based upon the nature of such lines of business with insureds of the Company, and current data regarding the limited severity and infrequency of such matters, it appears that potential environmental risks are not a significant portion of claims reserves and therefore would not likely have a material impact, if any, on the financial condition or results of operations of the Company. NOTE 4. NOTES PAYABLE During 1996, Chandler USA entered into a three year loan agreement with a bank having a principal amount of $4,500,000 and a floating interest rate at Wall Street Journal Prime. Monthly payments were $142,000 including principal and interest. Among other things, the loan agreement precludes Chandler USA from paying shareholder dividends, issuing stock and limits indebtedness. Moreover, the loan agreement requires that certain restrictive covenants be met. At December 31, 1997, Chandler USA was in compliance with all financial covenants. Proceeds from the note were used to repay intercompany advances from Chandler Barbados. During the fourth quarter of 1997, the related loan agreement was amended to provide for additional borrowings up to $8.5 million and to revise the term to five years with interest payable at a floating rate equal to 1% over Wall Street Journal Prime, which was 8.5% at December 31, 1997. The revised monthly payment is approximately $179,000 including principal and interest. The principal balance of the note was approximately $4,166,000 and $2,646,000 at December 31, 1996 and 1997, respectively. The principal balance at December 31, 1997 is net of an unamortized loan origination fee of $82,000. All or a portion of the available borrowing capacity under the note may be used to post needed bonds or to discharge litigation judgments. The bank note is collateralized by the shares of NAICO stock owned by Chandler USA. Chandler USA has a note payable related to the acquisition of Network with a balance of $225,000 and $150,000 at December 31, 1996 and 1997, respectively. The note has an interest rate of 7% and is payable in annual installments of $75,000 plus interest on October 11, 1998 and 1999. PAGE F-13 In February 1998, Chandler USA entered into a five year loan agreement with a bank having a principal amount of $2,300,000 and an interest rate of 7.75%. Monthly payments are $46,482 including principal and interest. The loan is collateralized by certain equipment which was purchased with the proceeds of the loan. The equipment had previously been leased by Chandler USA. The annual maturities of the notes payable, based upon the amounts borrowed as of December 31, 1997 and including the February 1998 loan, are as follows:
(In thousands) 1998..............................$ 2,376 1999.............................. 1,251 2000.............................. 453 2001.............................. 490 2002.............................. 529 Thereafter........................ 79 ------- $ 5,178 =======
NOTE 5. SHAREHOLDERS' EQUITY CAPITAL STOCK On May 7, 1988, the Company's shareholders authorized the issuance of up to 3,000,000 preferred shares with a par value of $1.00. No preferred shares have been issued as of December 31, 1997. The provisions of Article XI of the Company's Articles of Association, which was adopted by the shareholders in 1988, prohibits business combinations lacking approval of the Continuing Directors (those not affiliated with a 20% or more shareholder) or 80% of the shareholders and may result in a prohibition against voting such shares held by a shareholder acquiring 20% or more or the common shares (and its affiliates and associates) if the Continuing Directors deny approval. In addition to the regulatory oversight of NAICO by the Nebraska Department of Insurance, the Company is also subject to regulation under the Nebraska Insurance Holding Company Systems Act (the "Holding Company Act"). In addition to various reporting requirements imposed on the Company, the Holding Company Act requires any person who seeks to acquire or exercise control over NAICO (which is presumed to exist if any person owns 10% or more of the Company's outstanding voting stock) to file and obtain approval of certain applications with the Nebraska Department of Insurance regarding their proposed ownership of such shares. In 1996, the Company acquired 567,350 shares of its stock previously held by Chandler USA and retired the shares. In accordance with the Companies Law (1995 Revision) of the Cayman Islands, the Company established the capital redemption reserve fund in the amount of $947,000 which is reflected as a component of shareholders' equity in the consolidated balance sheets as of December 31, 1996 and 1997. See Note 10 regarding stock held by a subsidiary of the Company and stock rescinded through litigation. Under Section 953(c) of the Internal Revenue Code of 1986 as amended (the "Code"), if U.S. persons indirectly own (i.e., through ownership of the Company) 25% or more of the total combined voting power of all classes of Chandler Barbados' stock entitled to vote or 25% or more of the total value of Chandler Barbados' stock, then each such person is required to include in his gross income a portion of any insurance income of Chandler Barbados attributable to a policy of insurance or reinsurance with respect to which the person (directly or indirectly) insured is a related person to a shareholder in Chandler Barbados ("related person insurance income" or "RPII"). Under these rules, all U.S. persons who own stock in the Company (including Chandler's U.S. subsidiaries) would generally be required, subject to the exception discussed hereinafter, to include in their gross incomes a portion of the RPII received by Chandler Barbados from NAICO. However, related person insurance income of Chandler Barbados need not be included in the income of a U.S. person who is not a "United States shareholder," as defined in Section 951(b) of the Code, if, at all times during Chandler Barbados' taxable year, less than 20% of the total combined voting power of all classes of stock of Chandler Barbados and less than 20% of the total value of Chandler Barbados is owned (directly or indirectly) by persons who are (directly or indirectly) insured under any policy of insurance or reinsurance issued by Chandler Barbados, or who are related persons to any such person. See Note 7 regarding possible taxation of certain income of the Company to U.S. shareholders with certain ownership percentages. PAGE F-14 STATUTORY FINANCIAL INFORMATION AND MINIMUM CAPITAL REQUIREMENTS Chandler, Chandler Barbados, NAICO Indemnity and NAICO are required to file financial statements with insurance regulatory authorities. Chandler and NAICO Indemnity file financial statements with The Monetary Authority in the Cayman Islands, and Chandler Barbados files financial statements with the Supervisor of Insurance in Barbados. NAICO is required to file financial statements with state regulatory authorities prepared on a statutory basis which differs from U.S. GAAP. Statutory net income and statutory surplus of NAICO are as follows:
1995 1996 1997 ---------- ---------- - ---------- (In thousands) Statutory net income.......................$ 1,123 $ 998 $ 6,737 Statutory surplus..........................$ 40,594 $ 42,373 $ 45,283
Chandler, NAICO Indemnity and Chandler Barbados are also required to maintain net worth subject to minimum requirements imposed by the applicable regulatory authorities. Chandler and NAICO Indemnity are required to maintain a net worth of the greater of (i) $120,000, or (ii) an amount equal to 20% of their net premiums earned. Chandler Barbados must have assets exceeding liabilities by (i) $125,000 where the premium income in the previous year did not exceed $750,000; or (ii) 20% of the premium income for the preceding year where the premium income exceeded $750,000 but did not exceed $5,000,000; or (iii) the aggregate of $1,000,000 and 10% of the amount by which the premium income in that fiscal year exceeded $5,000,000. The National Association of Insurance Commissioners has adopted risk-based capital ("RBC") standards for domestic property-casualty insurance companies. The RBC standards are designed to assist insurance regulators in analytically determining a level of capital and surplus that would be sufficient to withstand reasonably foreseeable adverse events associated with underwriting risk, investment risk, credit risk and loss reserve risk. NAICO is subject to the RBC standards. Based on available information, management believes NAICO complied with the RBC standards at December 31, 1996 and 1997. At periodic intervals, various insurance regulatory authorities routinely examine the required financial statements as part of their legally prescribed oversight of the insurance industry. Based on these examinations, the regulators can direct such financial statements to be adjusted in accordance with their findings. DIVIDEND RESTRICTIONS As a holding company, the Company may receive cash through equity sales, borrowings and dividends from its subsidiaries. Chandler Barbados and NAICO are subject to regulations which restrict their ability to pay shareholder dividends. The payment of cash shareholder dividends by Chandler Barbados to the Company is limited to its earned surplus (approximately $38.0 million at December 31, 1997) and margin of solvency requirements. The amount of cash shareholder dividends that NAICO can pay to Chandler USA within any one year without the approval of the Nebraska Department of Insurance is generally limited to the greater of (i) statutory net income excluding realized capital gains for the preceding year (statutory net income excluding realized capital gains from the second and third preceding years, less any dividends paid, may be carried forward), or (ii) 10% of statutory surplus as regards policyholders as of the preceding December 31 with such amount not to exceed NAICO's statutory earned surplus. Based on this criteria the maximum shareholder dividend NAICO may pay in 1998 without the approval of the Nebraska Department of Insurance is approximately $8.1 million. The payment of shareholder dividends depends upon the earnings, financial position and cash requirements of the Company, as well as regulatory limitations, including such other factors as the Board of Directors may deem relevant. Chandler Barbados and NAICO (during the ownership by the Company) have not paid any cash shareholder dividends as of December 31, 1997. NAICO is subject to regulations which restrict its ability to pay dividends to policyholders. The maximum amount of available policyholder dividends is limited to statutory earned surplus (approximately $12.6 million as of December 31, 1997). NAICO paid approximately $452,000, $526,000 and $423,000 in policyholder dividends during 1995, 1996 and 1997, respectively. See Note 4 regarding a bank loan which precludes Chandler USA from paying shareholder dividends. NOTE 6. STOCK OPTIONS AND WARRANTS The Company has a non-qualified stock option plan (the "Plan") for which the Company has reserved an aggregate of 968,750 shares of its common stock subject to adjustment for reorganizations, recapitalizations, stock splits or similar events, for issuance upon exercise of options to be granted under the Plan. Options are granted at a purchase price of the fair market value as of the grant date. Shares of common stock subject to the unexercised portions of any options granted under the Plan which terminate or are canceled may again be subject to reissuance under the Plan. Officers of the Company and its subsidiaries are eligible to receive options under the Plan. The Plan is administered by a committee of the Company's outside directors appointed by the Board of Directors of the Company. No stock options or warrants were outstanding from January 1, 1995 through December 31, 1997. PAGE F-15 NOTE 7. INCOME TAXES Chandler, Chandler Barbados and NAICO Indemnity have received tax concessions from the Cayman Islands and Barbados governments for all taxes levied on profits, income, gains and appreciation that are valid through September 30, 2003, May 19, 2003 and March 10, 2012, respectively. Accordingly, no income taxes have been provided. The companies do not consider themselves engaged in a trade or business within the United States and therefore are not subject to United States Federal income tax. Should the Internal Revenue Service ("IRS") determine that any of the companies are engaged in a trade or business within the United States and has not filed a federal income tax return, such company may be subject to federal income tax and may not be allowed any deductions or credits in determining its tax liability. In late 1994 the IRS proposed increases in federal income tax and the imposition of federal withholding tax and penalties payable by Chandler USA and its wholly owned subsidiaries for calendar years 1989 through 1992 in the approximate amount of $2.5 million plus interest. The proposed adjustments to the federal income tax liability were attributable in part to a proposed increase in the income of Chandler USA for calendar year 1992 in the amount of $348,000 which, the IRS asserted, was Chandler USA's share of the Company's subpart F income for that year. The remaining proposed increase in income tax arose from the disallowance of deductions for certain expenses (primarily litigation costs - see Note 10), incurred by Chandler USA in calendar years 1991 and 1992, and the subsequent disallowance of a net operating loss carryback to calendar years 1989 through 1991. The proposed withholding tax assessment arose out of an assertion by the IRS that certain of the non- deductible expenses were incurred for the benefit of the Company, that they should be treated as a deemed distribution by Chandler USA to the Company, and as such should be subject to a 30% U.S. withholding tax. Chandler USA did not agree with the adjustments and filed a written protest of the proposed adjustments on December 23, 1994. The IRS contended that Chandler Barbados did not qualify for the exception to the inclusion of RPII for all U.S. persons who hold the Company's stock, because the Company owns more than 20% of the voting power and value of Chandler Barbados, and the Company is a related party to NAICO, which purchases reinsurance from Chandler Barbados. However, the Company believes, and asserted to the IRS that U.S. persons who hold less than 5.5% of the stock of the Company should not be required to include any RPII of Chandler Barbados in their income. The IRS has agreed with the Company's position on this issue, and a formal closing agreement was executed in 1996. During the fourth quarter of 1995, after numerous discussions and preliminary consensus with the IRS, Chandler USA made a provision for possible assessments of additional taxes through 1992 and additional taxes attributable to amended returns for 1993 and 1994 in the amount of $536,000. During 1996, the IRS and Chandler USA executed a formal closing agreement, Chandler USA paid the taxes for the open tax years (1989 through 1994) and the IRS closed its examination. During 1996, the IRS conducted a field examination of the U.S. Federal income tax returns of Chandler USA and its wholly owned subsidiaries for the years 1993 and 1994. The IRS completed the examination in the fourth quarter of 1996. Chandler USA has been informed by the IRS that there are no proposed adjustments to tax liabilities. Chandler USA and its wholly owned subsidiaries file a consolidated U.S. Federal income tax return. The income taxes reflected in the accompanying consolidated statements of operations differs from that expected using U.S. Federal enacted income tax rates for the following reasons:
1995 1996 1997 ---------- ---------- - ---------- (In thousands) Computed tax expense at 34%................$ 1,561 $ 223 $ 413 Increase (decrease) in income taxes resulting from: Expense (benefit) from income (loss) not subject to U.S. Federal income tax..... (2,086) (943) 1,384 Amortization of licenses and other intangibles...................... 368 380 380 Tax on 1995 subpart F income............. 114 - - Settlement of U.S. Federal income tax liability through 1992 and adjustments to prior years' accruals............... 724 - - Nontaxable income from legal settlement.. - (110) - - Other, net............................... 131 133 104 ---------- ---------- - ---------- Federal income tax provision (benefit).....$ 812 $ (317) $ 2,281 ========== ========== ==========
PAGE F-16 U.S. Federal income tax expense (benefit) consists of:
CURRENT DEFERRED TOTAL ---------- ---------- - ---------- (In thousands) 1995.......................................$ 845 $ (33) $ 812 1996....................................... (592) 275 (317) 1997....................................... 2,389 (108) 2,281
Deferred tax expense (benefit) relating to temporary differences includes the following components:
1995 1996 1997 ---------- ---------- - ---------- (In thousands) Loss reserve discounts.....................$ 174 $ 450 $ (97) Unearned premiums.......................... (250) (292) (58) Deferred policy acquisition costs.......... 20 158 1 Reserve for uncollectible accounts......... (153) 45 188 Depreciation and lease expense............. 21 (134) (164) Other...................................... 155 48 22 ---------- ---------- - ---------- $ (33) $ 275 $ (108) ========== ========== ==========
The tax effect of temporary differences between the consolidated financial statements carrying amounts and tax bases of assets and liabilities that give rise to significant portions of the net deferred tax assets, which are included in other assets, at December 31, relate to the following:
1996 1997 ---------- - ---------- (In thousands) Deferred tax assets: Loss reserve discounts...............................$ 3,597 $ 3,694 Unearned premiums.................................... 1,767 1,825 Reserve for uncollectible accounts................... 227 39 Unrealized loss on investments available for sale.... 299 - Net operating loss carryforwards - State............. 1,361 1,559 Other................................................ 128 106 Valuation allowance..................................... (1,361) (1,559) ---------- - ---------- Total deferred tax assets............................... 6,018 5,664 ---------- - ---------- Deferred tax liabilities: Deferred policy acquisition costs.................... 1,180 1,181 Depreciation and lease expense....................... 907 743 Unrealized gain on investments available for sale.... - 166 ---------- - ---------- Total deferred tax liabilities.......................... 2,087 2,090 ---------- - ---------- Net deferred tax asset..................................$ 3,931 $ 3,574 ========== ==========
At December 31, 1997 Chandler USA had available for Oklahoma state tax purposes net operating loss carryforwards totaling approximately $26 million which expire in the years 2004 through 2013. A valuation allowance has been provided for the tax effect of the state net operating loss carryforwards since realization of such amounts is not assured. NOTE 8. EMPLOYEE BENEFITS Chandler USA and subsidiaries participate in a defined contribution retirement plan established under Section 401(k) of the Code. All full time employees who meet certain eligibility requirements may elect to participate in the 401(k) plan. Participants may contribute up to 15% of compensation, not to exceed $9,500 per year as indexed. During 1995, Chandler USA matched 50% of employee contributions up to a maximum employer contribution of $1,000 per year per employee. Beginning January 1, 1996, the Company matched 50% of the first $2,000, 40% of the next $3,000, 30% of the next $3,000 and 25% of the remaining employee contributions up to a maximum employer contribution of $3,475 per employee per year. In addition, Chandler USA may make additional annual contributions to the 401(k) plan at its discretion. Chandler USA's expense for 401(k) plan contributions was $402,000, $249,000 and $254,000 for 1995, 1996 and 1997, respectively. PAGE F-17 NOTE 9. FAIR VALUE DISCLOSURES OF FINANCIAL INSTRUMENTS The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of SFAS 107, DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS. The estimated fair value amounts have been determined by the Company, using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates of fair values presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. A number of the Company's significant assets (including deferred policy acquisition costs, property and equipment, reinsurance recoverables, prepaid reinsurance premiums, licenses and excess of cost over net assets acquired) and liabilities (including unpaid losses and loss adjustment expenses and unearned premiums) are not considered financial instruments. The Company has concluded that the carrying value of other assets and liabilities considered financial instruments such as cash, premiums receivable, policyholder deposits, accrued taxes and other payables, notes payable and premiums payable approximates their fair value as of December 31, 1996 and 1997. The estimated fair values of the Company's fixed-maturity and equity security investments are disclosed at Note 2. NOTE 10. LITIGATION CENTRA LITIGATION -- GENERAL BACKGROUND CenTra is a Detroit-based holding company primarily engaged in the trucking industry. Beginning in 1987, NAICO insured CenTra's automobile liability, general liability and workers compensation risks through reinsurance arrangements involving DuraRock Underwriters, Ltd. ("DuraRock"), a Barbados company and an affiliate of CenTra, its predecessor Can-Am Underwriters, Ltd. ("Can-Am") and Chandler Barbados. In addition to the insurance arrangements, CenTra and its affiliates have been significant shareholders in the Company (holding approximately 22.7% of the Company's common stock at July 1, 1992). Three present or former executive officers of CenTra, Norman E. Harned, Ronald W. Lech and M. J. Moroun, are directors of the Company. Beginning in 1992, the relationships between the Company and CenTra deteriorated largely due to differences about the CenTra insurance program, CenTra's failure to make timely premium payments and CenTra's role in an anticipated management-led tender offer. In an apparent attempt to block the tender offer and seize control of the Company, CenTra began, on July 1, 1992, a series of common stock purchases and offers to purchase that would, over the following two weeks, place almost one-half of the Company's common stock with CenTra and its affiliates. On July 1 and 2, 1992, CenTra made an offer to Chandler USA, an indirect subsidiary of the Company, to purchase 1,117,679 common shares. These common shares were either owned by Chandler USA (567,350 common shares) or pledged to a subsidiary and owned by Cactus Southwest Corp. (169,858 common shares) or the Universal Insurance Group (380,471 common shares). Chandler USA declined the offer. On July 2, 1992, NAICO and NAICO Indemnity canceled the CenTra insurance policies for non-payment of premiums effective September 5, 1992. On July 2, 1992, CenTra made an offer to Cactus Southwest Corp. to purchase 169,858 common shares owned by it but pledged to the Chandler USA subsidiary to collateralize certain receivables. On July 7, 1992, the Nebraska Department of Insurance (the "Department") ordered CenTra to cease and desist purchases of the Company's common shares. On July 9, 1992, M.J. Moroun withdrew CenTra's prior offer to Cactus Southwest Corp. and offered to purchase the same common shares himself. At the same time, he began purchasing common shares in the open market. On July 10, 1992, the Department ordered CenTra and its affiliates and Messrs. M.J. Moroun, Harned and Lech to cease and desist purchases of the Company's common shares. On the same date, M.J. Moroun made an offer to the Universal Insurance Group to purchase 380,471 common shares owned by it but pledged to the Chandler USA subsidiary, and M.J. Moroun made further open market purchases. On July 11, 1992, M.J. Moroun paid $100,000 to the Universal Insurance Group for an irrevocable proxy and contracted with it for the purchase of its pledged common shares. On July 12, 1992, M.J. Moroun contracted with Cactus Southwest Corp. for the purchase of its pledged common shares. On July 13, 1992, further open market purchases were made in the name of Can-Am, a not-yet-formed Bahamian affiliate of CenTra. Also on July 13, 1992, the District Court for Lancaster County, Nebraska entered a temporary restraining order against CenTra, Messrs. M.J. Moroun, Harned and Lech, John and Jane Doe, XYZ Corporation, and their affiliates known and unknown, prohibiting further purchases. On July 14 and 17, 1992, the stock brokerage firm through which the open market purchases were made purportedly substituted Can-Am for M.J. Moroun as the purchaser on the July 9 and 10 sales confirmations. At some time after July 13, 1992, M.J. Moroun assigned his rights to purchase the pledged shares of the Universal Insurance Group and Cactus Southwest Corp. to Can-Am; neither CenTra nor Can-Am now claim ownership or any interest in the shares. During the second quarter of 1997, ownership of 380,471 shares was transferred to a Chandler subsidiary as payment for one of the agent's debts. In December 1997, 114,146 shares were transferred to a Chandler subsidiary and the balance of the pledged shares were transferred to unaffiliated persons and entities. These transactions had the effect of canceling the debts secured by the shares. The shares are held as a reduction of shareholders' equity. PAGE F-18 Through the above transactions, CenTra and its affiliates acquired, or contracted to acquire, an additional 26.5% of the Company's common stock, bringing their total claimed stock ownership to 49.2% in July 1992. The tender offer, which commenced on July 9, 1992 without knowledge of the open market purchases, was withdrawn on July 23, 1992. As these developments unfolded, CenTra or its affiliates or both initiated litigation in Oklahoma, Arkansas and Michigan, and an administrative proceeding in Nebraska, the domicile of NAICO. CENTRA LITIGATION -- OKLAHOMA BACKGROUND OF OKLAHOMA LAWSUIT. On July 16, 1992, CenTra and Messrs. M.J. Moroun, Lech and Harned filed a lawsuit in the United States District Court for the Western District of Oklahoma against the Company, the other corporations participating in the tender offer, and various individuals including certain officers and employees of the Company and its subsidiaries and the remaining directors of the Company, except Mr. Paul Maestri. The lawsuit sought declaratory and injunctive relief to prevent the tender offer alleging breaches of fiduciary and other duties and violations of the federal securities laws. After the tender offer was withdrawn, the plaintiffs amended their complaint on August 5, 1992, alleging breaches of fiduciary and other duties by commencing the tender offer and violations of federal securities laws in the tender offer and in certain transactions since 1988. The Company and the other defendants denied any breaches of duty or violations of law and the Company filed various counterclaims against CenTra and various affiliates alleging breaches of fiduciary duties and violations of federal securities laws in their attempts to seize control of the Company through the July 1992 stock purchases, and sought damages, costs and attorney fees. The Company also asserted a counterclaim against M.J. Moroun, individually, based upon his alleged violation of Section 16(b) of the Securities Exchange Act of 1934 regarding "short swing" profits. On January 6, 1993, the plaintiffs filed a second amended complaint (i) asserting violations of federal securities laws and a breach of contract claim in a 1988 stock purchase; (ii) asking the court to declare invalid and unenforceable a corporate resolution based on Article XI of the Company's Articles of Association (prohibiting certain business combinations) that prohibits Can-Am and its affiliates (including CenTra) from voting their shares of the Company's common stock; and (iii) asserting derivative claims for fiduciary misconduct, unjust enrichment, fraud and/or breach of contract in the tender offer, for management bonuses in 1988 and 1989, in the Company's purchase of three management-related agencies in 1988, and for assorted improper personal benefits. All of these derivative claims seek unspecified damages, restitution and/or injunctive relief on behalf of the Company, including punitive damages, attorneys' fees and costs. In 1994 the plaintiffs made a request to file a third amended complaint. The Court denied that request. A three member committee ("Special Committee"), who are on the board of directors of NAICO and are not named in the lawsuits, investigated the derivative claims. The Special Committee concluded the Company should take no action against the individual defendants regarding the claims relating to the tender offer, the management bonuses and the agency purchases. As to the allegedly improper personal benefits, the Special Committee found that some were ordinary and necessary business expenses while others were not. The Special Committee recommended that the recipients reimburse the Company or the affected subsidiaries for all improper personal benefits, the full value of which was $135,000. The respective Boards of Directors of the Company and the affected subsidiaries accepted the report and recommendations of the Special Committee and retained special legal counsel to implement the recommendations of the Special Committee. Messrs. M.J. Moroun, Lech and Harned dissented. On July 20, 1992, CenTra sued NAICO in the Circuit Court of Macomb County, Michigan alleging that NAICO and certain officers and directors wrongfully canceled insurance policies issued to CenTra. CenTra claimed that the cancellation was retaliation for CenTra's decision not to participate in the tender offer, requested that the policies be reinstated, and sought monetary damages for the wrongful cancellation. The case was removed to the U.S. District Court for the Eastern District of Michigan. NAICO replied that the cancellation was proper based on CenTra's continuing failure to pay premiums. After two extensions of the cancellation date, the policies were canceled effective on September 5, 1992 after CenTra acquired replacement insurance. On August 26, 1992, CenTra deposited $700,000 with the court clerk under court order as security for premiums due under the NAICO policies. On October 13, 1992, the court granted defendants' motion to transfer the action to the U.S. District Court for the Western District of Oklahoma. On January 27, 1993, plaintiff filed an application in the Court of Appeals for the Sixth Circuit contending that the district court abused its discretion by transferring the case to Oklahoma. The application was denied. CenTra then filed a motion in the U.S. District Court in Oklahoma to transfer the case to Michigan. The U.S. District Court in Oklahoma retained jurisdiction of the case. NAICO filed a claim seeking payment of the unpaid premiums and contended that the cancellations were proper and denied that CenTra suffered any damages as a result of the cancellations, or any action taken by NAICO associated with the cancellations. OKLAHOMA JUDGMENTS - APRIL 22, 1997, MARCH 10, 1998. On February 13, 1997, trial commenced in the United States District Court in Oklahoma City, Oklahoma (the "Oklahoma Federal Court") in the consolidated cases involving CenTra and certain of its affiliates, officers and directors (the "CenTra Group") and the Company and certain of its affiliates, officers and directors. On April 1, 1997, at the close of all of the evidence, the Court entered judgment in favor of NAICO on CenTra's claims for alleged wrongful cancellation of CenTra's insurance with NAICO and the affiliate in 1992. See CenTra Litigation - Other. The remaining issues were submitted to a jury. PAGE F-19 On April 9, 1997, the jury returned verdicts on all claims. On April 22, 1997, the Oklahoma Federal Court entered judgments on all verdicts returned. One judgment against the Company requires the CenTra Group to return stock it purchased in 1990 to the Company in return for a payment of $5,099,133 from the Company. Another judgment was against both the Company and its affiliate Chandler Barbados and in favor of CenTra and its affiliate Ammex, Inc. Based upon an alleged breach of a stock purchase agreement in 1988, CenTra and Ammex were awarded $6,882,500. Both judgments related to alleged failures by the Company to adequately disclose the fact that ownership of the Company's stock may be subject to regulation by the Nebraska Insurance Department under certain circumstances. The jury also found in favor of CenTra and against certain officers and/or directors of the Company on the securities claims relating to CenTra's 1990 purchases and the failure to disclose the application of Nebraska insurance law, but awarded damages of $1 against each individual defendant on those claims. On ten derivative claims brought by CenTra, the jury found in CenTra's favor on three. Certain officers were directed to repay to Chandler USA bonuses received for the years 1988 and 1989 totaling $711,629 and a total of $25,000 for personal use of corporate aircraft. On the remaining claim relating to the acquisition of certain insurance agencies in 1988, the jury awarded $1 each against six officers and/or directors. On other claims asserted by the CenTra Group, the jury found in favor of the Company and/or the individual defendants. The jury also found in favor of NAICO and NAICO Indemnity on their counterclaims for CenTra's failure to pay insurance premiums in the sum of $788,625 and further upheld a resolution adopted by the Chandler Board of Directors in August 1992 pursuant to Article XI of the Company's Articles of Association preventing CenTra and its affiliates from voting their Chandler stock as a result of purchases made by the CenTra Group in July 1992 as part of its efforts to acquire control of Chandler. The jury found in favor of CenTra on the Company's claim against CenTra for breach of a standstill agreement contained in a 1988 stock exchange agreement. The jury denied the Company's claim against Messrs. Harned, Lech and Moroun based upon their alleged breach of fiduciary duty as directors. The jury also denied the Company's claim against Mr. Moroun individually for violation of Section 16(b) of the Securities Exchange Act of 1934 regarding short swing profits. Several post-trial motions were filed by all parties relating to the judgments and prejudgment interest. The Oklahoma Federal Court ordered that additional motions for costs and attorney fees be filed within 20 days following rulings on these motions. However, on October 11, 1997 CenTra filed motions for costs and attorneys fees totaling $4.7 million. The Company responded by contending that the motions were filed prematurely and are, in any event, without merit. As a result of the Oklahoma Federal Court judgments, the Company recorded a net charge for the litigation matters described above during the first quarter of 1997 totaling approximately $8.3 million ($8.5 million including provision for federal income tax). In addition, the Company recorded the return of 517,500 shares of the Company's stock in conjunction with the stock rescission judgment as a decrease to shareholders' equity in the amount of approximately $4.9 million with the remaining amount included in the charge for litigation matters. The charge includes approximately $4.6 million as an estimate of interest, costs and related attorney fees. The charge includes an estimated recovery of $2.7 million from the Company's directors and officers policy insurer for costs associated with the defense and litigation of these matters. The Company is entitled to a total of $5 million under the applicable insurance policy. Some amounts have been previously paid without dispute and the Company is negotiating with the insurer for payment of the policy balance. The Company could recover the remaining policy limits or could compromise its claim, and could incur significant costs in either case. The estimated insurance recovery is based upon these variable factors. The charge also includes the amount of judgments in favor of Chandler USA on the derivative claims discussed above. Except for the recovery of a portion of the litigation costs from the Company's directors and officers policy insurer, no provision has been made in the accompanying consolidated financial statements related to the advancement of litigation expenses to certain defendants. On March 10, 1998, the Oklahoma Federal Court disposed of all post-trial motions filed by the parties. The parties had asked the Oklahoma Federal Court to vacate or modify judgments unfavorable to them and requested the Oklahoma Federal Court to award prejudgment interest. The Oklahoma Federal Court overruled all pending motions except a motion by the Company and Chandler Barbados to require CenTra and its affiliates to deliver 1,142,625 Shares of Chandler common stock they own or control upon payment of the $6,882,500 judgment which was entered in CenTra's favor in April 1997. The Company has recorded the return of 1,142,625 shares of the Company's stock in conjunction with the order as a decrease to shareholders' equity as of December 31, 1997, and reduced the previous first quarter of 1997 net charge for litigation matters by $6,882,500. The CenTra parties were directed to deliver the shares upon payment of the judgment. CenTra's pending motion for an award of costs and attorney fees was stricken and all parties were granted leave to file such motions within 20 days of March 10, 1998. On March 16, 1998 CenTra and its affiliates filed such motions seeking an award of costs and attorney fees totaling approximately $4.7 million. All parties may appeal any or all of the orders of the Oklahoma Federal Court. On March 23, 1998, CenTra and its affiliates filed a formal notice of intent to appeal certain orders of the Oklahoma Federal Court but have not yet stated specifically the claims or issues they or any of them will appeal. PAGE F-20 Because all shares of the Company's stock owned by CenTra and its affiliates are held by the U.S. District Court for the District of Nebraska ("Nebraska Court") it is unclear when or if CenTra and its affiliates will be able to comply with the Oklahoma Federal Court's order. The Company believes that it is not required to pay the judgments until CenTra and its affiliates can deliver the shares to the Company. The ultimate actual amounts resulting from potential motions for the award of costs and attorney fees plus matters related to potential appeals by the parties could result in amounts significantly different from the Company's estimates, and could have a material adverse effect on the Company and could negatively impact future earnings. On April 28, 1997, the Company's Board of Directors appointed a Committee of the Board (the "Committee") to deal with all matters arising from the Oklahoma litigation. The Committee was delegated all authority of the Board on these issues. The members of the Committee are Messrs. Jacoby, Maestri and Davis, all of whom are non-parties to the CenTra litigation. The Committee has retained independent counsel. The individual members of the Committee review issues relating to litigation strategy, officer and director indemnification, and claims made under the Company's director and officer liability insurance policy on a regular basis in conjunction with a similar committee composed of Chandler USA directors. The Committee conducts its meetings outside the United States, but participates in telephone briefings and discussions at least twice monthly. All implications of the Oklahoma Federal Court's ruling have not been fully evaluated by the Company. These issues are being studied by the Company's management and the Committee. In the event that the Company should decide to appeal, it may be required to post a supersedeas bond or bonds to suspend execution of any judgments against it. The Company believes that if it elects to pay the judgments, the shares owned by CenTra or its affiliates which are the subject of the judgment must be returned to the Company unless CenTra appeals and takes appropriate action to supercede the judgments, or the Nebraska Court does not release the shares. The Company's management believes that adequate financial resources are available to post a supersedeas bond or to pay the judgments. As a holding company, the Company may receive cash through equity sales, borrowings and dividends from its subsidiaries. Chandler Barbados and NAICO are subject to various regulations which restrict their ability to pay shareholder dividends. A reduction in the amount of invested assets, or an increase in borrowings resulting from potential payment of these judgments would reduce investment earnings or increase operating expenses in future periods. Chandler USA is the judgment creditor in connection with derivative claim judgments against certain Chandler officers and directors. Chandler USA's Special Litigation Committee is considering the course of action Chandler USA should take with regard to collection of those judgments. CENTRA LITIGATION -- NEBRASKA ADMINISTRATIVE. NAICO, which is domiciled in Nebraska, is regulated by the Nebraska Department of Insurance (the "Department"). The Department requires a Form A application and prior approval by the Department from anyone seeking to acquire control, directly or indirectly, of an insurance company regulated by the Department. CenTra, Can-Am and their affiliates filed a Form A application with the Department to which the Company and certain of its affiliates objected. On October 28, 1992, the Department denied CenTra's Form A application. The Department found that (i) the financial condition of the CenTra Group might jeopardize the financial stability of NAICO or prejudice the interests of policyholders; (ii) the competence, experience and integrity of the CenTra Group is such that it would not be in the best interests of policyholders or NAICO or the public for the CenTra Group to control NAICO; and (iii) the acquisition is likely to be hazardous or prejudicial to the public. The CenTra Group appealed the Department's order to the Lancaster County District Court for the State of Nebraska ("District Court"). The District Court affirmed the Department's order on September 21, 1993. On December 1, 1995 the Nebraska Supreme Court affirmed the Department and the District Court decisions. On May 13, 1996 the U.S. Supreme Court denied the CenTra Group's Petition for Writ of Certiorari, thereby declining to review the decision of the Nebraska Supreme Court. PAGE F-21 NEBRASKA COURT ACTION. On October 6, 1995 Agnes Anne Moroun, sister of M.J. Moroun, purported to acquire 1,441,000 shares of the voting stock of the Company (the "Shares") from Can-Am Investments, Ltd., an affiliate of three of the Company's directors, M.J. Moroun, Norman E. Harned, and Ronald W. Lech. In response to that action, NAICO filed an action on October 11, 1995 in the District Court seeking an order sequestering the Shares based upon alleged violations of the Nebraska Holding Company Systems Act and orders of the Nebraska Department of Insurance. NAICO also sought a temporary order enjoining further transfers of the Shares and an order requiring the custodian of the Shares, Dean Witter, to deliver them to the court. Agnes Anne Moroun, M.J. Moroun, Norman E. Harned, and others removed the action to the Nebraska Court on October 17, 1995. The Nebraska Department of Insurance intervened on that same date requesting relief substantially similar to that requested by NAICO. The Honorable Warren K. Urbom conducted a hearing on October 18, 1995 and on October 30, 1995 granted the relief requested by NAICO. On October 31, 1995 the order was amended and was extended to 700 shares held by Can-Am Investments, Ltd. and was extended to include the CenTra Group's claim to rights to acquire stock. Dean Witter was directed to cause share certificates to be issued and delivered to the Clerk of the Nebraska Court. On November 8, 1995 the share certificates were issued listing Can-Am Investments, Ltd. as the shareholder of 1,441,700 shares pursuant to the order of the Nebraska Court. On November 2, 1995, Agnes Anne Moroun and the other defendants filed responsive pleadings and counterclaims against NAICO and the Director of Insurance of the State of Nebraska ("Insurance Director"). The counterclaims sought declaratory relief confirming the validity of the purported October 6, 1995 transfer of the Shares and that the Insurance Director and the courts of the State of Nebraska are without authority to sequester the Shares. The counterclaims also seek a judgment determining that NAICO's current management controls the Company without the approval of the Insurance Director and incidental relief. The Nebraska Court ruled in favor of NAICO on the counterclaims. On March 25, 1997 the Nebraska Court, pursuant to the Nebraska Insurance Holding Company Systems Act, ordered CenTra and certain of its affiliates to divest all Chandler shares owned by them, regardless of when purchased. The CenTra defendants own or control 3,133,450 Chandler shares. All such shares are currently in the possession of the Nebraska Court pursuant to the 1995 and 1997 orders of the Nebraska Court (including the shares subject to the Oklahoma Federal Court stock rescission judgments). CenTra's shares represent approximately 45.1% of the outstanding stock (including the shares subject to the Oklahoma Federal Court stock rescission judgments and the stock held by subsidiary). The Nebraska Court directed NAICO, the CenTra defendants and the Nebraska Insurance Department to submit proposals to the Nebraska Court by April 21, 1997 for the "orderly divestiture and disposition of the stock". A hearing would then be scheduled to consider the proposals. CenTra has subsequently appealed the March 25, 1997 order of the Nebraska Court to the United States Court of Appeals for the Eighth Circuit where the appeal is now pending. Oral argument is currently scheduled for April 1998. CenTra's appeal of this order has resulted in a delay of the deadlines for submitting the proposals and no new submission date has been set at this time. On October 7, 1997 the Honorable Warren K. Urbom, U.S. District Judge for the Nebraska Court, ordered CenTra, M.J. Moroun and others to deliver into the registry of the Nebraska Court by November 6, 1997 all shares of Chandler stock owned or controlled by them or their affiliates not previously tendered, to await the outcome of the appeal of his divestiture order. CenTra requested a stay of that order. The stay was denied by Judge Urbom and CenTra was again ordered to deliver their shares to the Nebraska Court, this time by January 12, 1998. CenTra appealed that order to the U.S. Court of Appeals for the Eighth Circuit, which affirmed Judge Urbom's order. On February 9, 1998 CenTra deposited an additional 1,691,750 shares with the Nebraska Court. Because of the uncertainty of the outcome of CenTra's appeal of the Nebraska Court's orders, and until the final proposals are submitted and accepted, the Company is unable to predict the effect of the divestiture order on the rights, limitations or other regulation of ownership of the stock of any existing or prospective holders of the Company's common stock, or the effect on the market price of the Company's stock. The impact of the March 10, 1998 ruling of the Oklahoma Federal Court (See CenTra Litigation - Oklahoma) upon the divestiture order is currently unclear. On March 27, 1997 the Nebraska Court declined to exercise jurisdiction over 550,329 shares of Chandler stock held as security by Chandler subsidiaries for debts owed by two former agents but in which CenTra claimed to have option rights. The Nebraska Court's ruling cleared the way for the Company's subsidiaries to begin the process of disposing of these shares to retire the agents' debts to the subsidiaries. CenTra did not appeal this order. During the second quarter of 1997, ownership of 380,471 shares was transferred to a Chandler subsidiary as payment for one of the agent's debts. In December 1997, 114,146 shares were transferred to a Chandler subsidiary and the balance of the pledged shares were transferred to unaffiliated persons and entities. These transactions had the effect of canceling the debts secured by the shares. The shares are held as a reduction of shareholders' equity. PAGE F-22 CENTRA LITIGATION - OTHER On September 25, 1997, NAICO learned that several CenTra affiliates had filed two lawsuits in state court in Macomb County, Michigan against NAICO, NAICO Indemnity and certain NAICO officers asserting the same claims made and tried in the Oklahoma lawsuit described above (See CenTra Litigation - Oklahoma). Those claims were purportedly prosecuted by CenTra on its own behalf and on behalf of its subsidiaries. The Oklahoma Federal Court entered a judgment against CenTra on these claims. The damages sought are unspecified but the claims are based upon NAICO's cancellation of CenTra's insurance in 1992. NAICO and NAICO Indemnity contend that the Oklahoma Federal Court's adjudication is conclusive as to all claims. The lawsuits were removed to the U.S. District Court for the Eastern District of Michigan, Southern Division ("Michigan Federal Court"). NAICO and NAICO Indemnity have filed dispositive motions which are currently under advisement. On February 28, 1998 the Michigan Federal Court ordered the lawsuits transferred to the Oklahoma Federal Court. During the first quarter of 1997 the Company concluded an arbitration proceeding involving DuraRock and recorded approximately $315,000 in litigation and settlement expenses related to this matter. Since December 31, 1997, the Company has also resolved various issues resulting in settlement of litigation and arbitration proceedings among subsidiaries of the Company and CenTra affiliates, and has recorded litigation and settlement expenses of approximately $147,000 in 1997. In the CenTra litigation, certain officers of the Company and the Company's directors other than Messrs. M.J. Moroun, Harned, Lech and Maestri were named as defendants. In accordance with its Articles of Association, the Company has advanced the litigation expenses of these persons in exchange for undertakings to repay such expenses if those persons are later determined to have breached the standard of conduct provided in the Articles of Association. The Company has paid expenses totaling approximately $2.1 million as of December 31, 1997. A portion of these expenses relate to claims which have been dismissed or which were decided in favor of the officers and directors. In addition, certain expenses may be recovered from the Company's directors and officers policy insurer. As a result of various events in 1995, the Company recorded an $818,000 estimated recovery of costs from its directors and officers policy insurer related to a $1 million claim for reimbursable amounts previously paid that relate to allowable defense and litigation costs for such parties. In 1996, the Company recorded an additional estimated recovery of $982,000. The Company received a payment for the 1995 claim during 1996 in the amount of $795,000. In connection with the Oklahoma Federal Court judgments, the Company recorded an additional estimated recovery of $2.7 million from the Company's directors and officers policy insurer. The Company is entitled to a total of $5 million under the applicable insurance policy. Some amounts have been previously paid without dispute and the Company is negotiating with the insurer for payment of the policy balance. The Company could recover the remaining policy limits or could compromise its claim, and could incur significant costs in either case. The estimated insurance recovery is based upon these variable factors. Except for the recovery of a portion of the litigation costs from the Company's directors and officers policy insurer, no provision has been made in the accompanying consolidated financial statements related to the advancement of litigation expenses to certain defendants. The Committee was delegated the authority of the Board to deal with all issues arising from the Oklahoma litigation including the issue of officer and director indemnification. At the present time the Company is actively participating in court proceedings, possible discovery actions and rights of appeal concerning these various legal proceedings; therefore, the Company is unable to predict the outcome of such litigation with certainty or the effect of such ongoing litigation on future operations. OTHER LITIGATION The Company and its subsidiaries are not parties to any other material litigation other than as is routinely encountered in their respective business activities. NOTE 11. COMMITMENTS AND CONTINGENCIES REINSURANCE In the ordinary course of business, NAICO and NAICO Indemnity cede insurance to other insurers and reinsurers under various reinsurance treaties that cover individual risks (facultative reinsurance) or entire classes of business (treaty reinsurance). Reinsurance provides greater diversification of business written and also reduces NAICO's and NAICO Indemnity's exposure arising from high limits of liability or from hazards of an unusual nature. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. NAICO has structured separate reinsurance programs for surety bonds, property, workers compensation, casualty (including automobile liability and physical damage, general liability, umbrella liability, and related professional liability) and group accident and health. Chandler Barbados reinsures NAICO for a portion of the risk on the surety bonds, workers compensation and casualty reinsurance programs. PAGE F-23 Under the 1997 workers compensation reinsurance program, the combined net retention for NAICO and Chandler Barbados was $1,000,000 of loss per occurrence. Effective February 1, 1998, the combined net retention was reduced to $500,000 of loss per occurrence. The combined net retention under the 1997 casualty reinsurance program was $500,000 of loss per occurrence. Effective February 1, 1998, the combined net retention was reduced to $250,000 of loss per occurrence. The combined net retention under the surety bond reinsurance program is $500,000 per bond or per principal (e.g. contractor). NAICO retains 30% of the first $500,000 of risk for each loss per location under its property reinsurance program. Under the group accident and health program, NAICO retains the first $50,000 in excess of the self-insured retention for each insured person, each policy, and the first $100,000 (or the first $250,000 for cases exceeding 400 covered employees) of losses in excess of the self-insured aggregate retention. In addition, NAICO purchases catastrophe protection to limit its retention for single loss occurrences involving multiple policies and/or policyholders, such as floods, winds and severe storms. NAICO also purchases facultative reinsurance when it writes a risk with limits of liability exceeding the maximum limits of its treaties or when it otherwise considers such action appropriate. Treaty reinsurance may be ceded under treaties on both a pro rata or proportional basis (where the reinsurer shares proportionately in premiums and losses) and an excess of loss basis (where only losses above a specific amount are reinsured). The availability, costs and limits of reinsurance purchased can vary from year to year based upon prevailing market conditions, reinsurers underwriting results and NAICO's desired retention levels. A majority of NAICO's reinsurance programs renew on January 1, April 1 and July 1 of each year. NAICO renewed all January 1 reinsurance programs. At the present time, NAICO expects to renew the reinsurance programs on April 1 and July 1. In formulating its reinsurance programs, NAICO considers numerous factors, the most important of which are the financial stability of the reinsurer, including its ability to provide sufficient collateral if required, coverage offered and price. NAICO periodically reviews certain prospective single year reinsurance treaties, subject to commutation provisions therein, to determine if it is advantageous to assume the estimated loss exposure on expired insurance policies covered by such treaties in exchange for return premiums. Commutation of such reinsurance treaties will be determined in future periods based on timely review of all available data. In 1995, NAICO elected to commute the unpaid losses and loss adjustment expenses related to reinsurance contracts covering certain business written in 1993, 1994 and 1995 which resulted in an increase in net premiums earned of $2,285,000. Beginning in 1996, NAICO reviewed the historical results for reinsurance contracts with similar commutation provisions and began accruing for such commutations where a commutation election was considered likely, which resulted in an increase in net premiums earned of $730,000 and $1,648,000 in 1996 and 1997, respectively. Reinsurance contracts do not relieve an insurer from its obligation to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company; consequently, allowances are established for amounts deemed uncollectible. NAICO charged $440,000, $2,078,000 and $527,000 to policy acquisition costs during 1995, 1996 and 1997, respectively, for estimated uncollectible reinsurance recoverables from certain unaffiliated reinsurers. The effect of reinsurance on premiums written and earned was as follows:
1995 1996 1997 -------------------- -------------------- - -------------------- WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED --------- --------- --------- --------- --------- - --------- (In thousands) Direct.........$ 95,520 $ 92,021 $103,801 $ 98,550 $123,014 $116,101 Assumed........ 3,248 2,614 4,142 4,664 74 608 Ceded.......... (14,128) (13,548) (14,228) (13,928) (26,222) (22,030) --------- --------- --------- --------- --------- - --------- Net premiums...$ 84,640 $ 81,087 $ 93,715 $ 89,286 $ 96,866 $ 94,679 ========= ========= ========= ========= ========= =========
Losses and loss adjustment expenses are reported net of the effect of reinsurance recoveries and recoverables in the consolidated statements of operations. Ceded losses and loss adjustment expenses were $6.6 million, $4.2 million and $10.6 million for 1995, 1996 and 1997, respectively. PAGE F-24 SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK NAICO conducts a substantial part of its business through individual independent insurance agencies and underwriting managers. Certain of these underwriting managers have provided collateral to NAICO to secure a portion of the premiums receivable. Substantially all of the principal shareholders of the independent agencies and underwriting managers have provided personal guarantees for payment of premiums to NAICO. NAICO also requires certain policyholders to pay a deposit at the time of inception of coverage to secure payment of future premiums. Receivables under installment plans do not exceed the corresponding liability for unearned premiums. Total consolidated premiums receivable at December 31, 1997 were $28.1 million. Receivables for deductibles, in most cases, are secured by cash deposits and letters of credit. At December 31, 1997, the Company maintained custody of such letters of credit securing these and other transactions totaling approximately $9.2 million, which is a reasonable estimate of their fair value. These letters of credit are not reflected in the accompanying consolidated financial statements. NAICO's largest unaffiliated independent insurance agent during 1995 was responsible for producing $11.0 million of NAICO's direct written and assumed premiums. There were no unaffiliated independent insurance agents that produced 10% or more of NAICO's direct written and assumed premiums during 1996 or 1997. NAICO's largest underwriting manager was responsible for underwriting $11.5 million, $11.9 million and $12.3 million of NAICO's direct written and assumed premiums for the California and Arizona portions of the nonstandard private-passenger automobile program in 1995, 1996 and 1997, respectively. Premiums receivable and currently due from this underwriting manager were $596,000 and $612,000 at December 31, 1996 and 1997, respectively. Approximately $3.0 million, or 12.9% of the Company's reinsurance recoverables at December 31, 1997 are collateralized by premiums payable to the reinsurers, securities pledged in trust or letters of credit for the benefit of NAICO. The Company believes the above value of such collateral is a reasonable estimate of their fair value. NAICO's reinsurance contracts include provisions for offsets against premiums owed to the reinsurers. The following table sets forth certain information related to NAICO and NAICO Indemnity's five largest reinsurers (excluding Chandler Barbados) by net reinsurance recoverables as of December 31, 1997.
NET A.M. REINSURANCE BEST CO. NAME OF REINSURER RECOVERABLE (1) RATING - --------------------------------- --------------- -------- (Dollars in thousands) Jefferson Insurance Company of New York.......... $ 4,523 A National Union Fire Insurance Company of Pittsburgh (2).... 3,930 A++ SCOR Reinsurance Company......... 3,831 A+ National American Insurance Company of California........ 1,123 B++ Transamerica Occidental Life Insurance Company....... 1,122 A+ --------------- Top five reinsurers.......... $ 14,529 =============== All reinsurers............... $ 23,607 =============== Percentage of total represented by top five reinsurers....... 61.5% - --------------------------------- (1) Includes losses and loss adjustment expenses paid and outstanding, unpaid losses and loss adjustment expenses and unearned premium reserves recoverable from reinsurers as of December 31, 1997. (2) National Union Fire Insurance Company of Pittsburgh, Pennsylvania assumed the reinsurance obligations of DuraRock Underwriters, Ltd. effective March 31, 1993.
OTHER See Note 10 regarding contingencies relating to litigation matters. Chandler USA entered into employment contracts with three executive officers of the Company and an employee of one of the Company's subsidiaries during 1988. Each employment agreement has an initial term of 10 years, extended by one additional year for each year worked beyond the fifth year, with final termination at age 70. The aggregate annual commitment for base salaries under these agreements is approximately $974,000. Under certain limited circumstances, such officers could receive base salaries subsequent to an early termination of their employment subject to certain continued obligations to Chandler USA. Effective May 1, 1997 one of these executive officers, Benjamin T. Walkingstick, ceased to be employed by the Company, but continues to serve as a consultant. On September 18, 1997 he entered into a separate contract with L&W relating to insurance sales on a commission basis. Commissions paid under this agreement during 1997 totaled $10,832. PAGE F-25 Chandler USA entered into employment contracts with three employees of Network in October 1995. Two of the contracts have been terminated and one with an initial five year term remains in effect. The aggregate annual commitment for base salary under this agreement is approximately $42,000. NAICO is subject to a variety of assessments related to insurance activities, including those by state guaranty funds and workers compensation second-injury funds. The amounts and timing of such assessments are beyond the control of NAICO. NAICO provides for these charges on a current basis by applying historical factors to premiums earned. Actual results may vary from these values and adjustments therefrom are necessary to maintain an adequate reserve for these assessments. The reserve for unpaid assessments was approximately $1.4 million and $865,000 at December 31, 1996 and 1997, respectively. In certain cases, NAICO is permitted to recover a portion of its assessments generally as a reduction to premium taxes paid to certain states. NAICO has recorded receivables in the amount that it expects to recover of approximately $158,000 and $64,000 at December 31, 1996 and 1997, respectively. At December 31, 1997, the Company's subsidiaries were committed under noncancellable operating leases for certain equipment and office space. Rental payments under these leases were $1.0 million in 1995 and $1.1 million in both 1996 and 1997. Future minimum lease payments are as follows:
(In thousands) 1998..............................$ 414 1999.............................. 151 2000.............................. 71 2001.............................. 56 2002.............................. 28 ------- $ 720 =======
The future minimum lease payments shown above exclude amounts for a previous equipment lease which was purchased and financed in February 1998. See Note 4 for additional information. NOTE 12. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS OPERATING TRANSACTIONS The net effect of the Company's primary operating transactions with related parties follow:
DECEMBER 31, - -------------------- BALANCE SHEETS 1996 1997 - ---------------------------------------------------------- -------- - -------- (In thousands) Premiums receivable....................................... $ 174 $ 789 Unpaid losses and loss adjustment expenses, net of reinsurance recoverable....................... 252 112 Accrued taxes and other payables.......................... 2,887 505 Premiums payable.......................................... 383 -
NAICO and NAICO Indemnity provided insurance coverage and risk management services for CenTra and certain of its affiliates (see Note 10). All such policies were canceled effective September 5, 1992 or expired as of September 30, 1992. As of December 31, 1997, the unpaid premiums and other amounts due from CenTra to the Company's subsidiaries were $788,625 as reflected by the April 22, 1997 jury verdicts. Liberty Bell Agency, Inc. ("Liberty Bell"), an affiliate of CenTra, has administered claims under the CenTra insurance program. NAICO and NAICO Indemnity reimburse Liberty Bell for their share of claim payments, but are not obligated for DuraRock's share. The Company intends to seek payment of all amounts due and believes a reserve for collection is not necessary at December 31, 1997. In addition, the Company's subsidiaries reflected a payable to certain affiliates of CenTra in the amount of $505,000 at December 31, 1997 in connection with the settlement of certain litigation and arbitration proceedings. DuraRock reinsured NAICO and NAICO Indemnity for substantially all CenTra risks underwritten by them. As a part of a settlement of certain related litigation, National Union agreed to assume the reinsurance obligations of DuraRock effective March 31, 1993. Reinsurance recoverables from National Union totaled approximately $32.1 million, $7.4 million and $3.9 million as of December 31, 1995, 1996 and 1997, respectively. The reduction in reinsurance recoverables as well as to the corresponding liabilities for unpaid losses and loss adjustment expenses is based upon information provided by Liberty Bell and National Union. Although NAICO's and NAICO Indemnity's risks are fully reinsured, they are ultimately liable as the policy-issuing company. If National Union does not meet its obligations, such failure could adversely affect NAICO and the Company (see Notes 10 and 11). PAGE F-26 OTHER See Note 10 regarding advancement of litigation expenses to certain officers and directors of the Company in the CenTra litigation. See Note 11 regarding an insurance commission agreement in 1997. A former director and officer and a current shareholder is Chairman of a bank used by the Company's U.S. subsidiaries as their principal disbursement bank. The Company's U.S. subsidiaries collectively maintain an average daily balance of approximately $300,000. The balance maintained by each subsidiary is fully insured by the Federal Deposit Insurance Corporation. The Company's U.S. subsidiaries have also leased automobiles from this bank. One of the Company's U.S. subsidiaries leases and has made certain improvements to a rural property owned by certain directors and/or officers of the Company. Under the lease, no cash rental is paid, but the subsidiary drilled a water well on the property and maintains certain structures it regularly uses. This property provides recreational activities for the entertainment of customers and business associates of the Company's U.S. subsidiaries. The Company incurred approximately $108,000, $184,000 and $159,000 in expenses associated with this property during 1995, 1996 and 1997, respectively. The Company believes that all transactions, including loans with directors, officers, or shareholders of the Company, are and will continue to be on terms no less favorable to the Company than could be obtained from unaffiliated parties. NOTE 13. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) The Company's quarterly results of operations (unaudited) for 1996 and 1997 are as follows:
BASIC EARNINGS TOTAL NET PER COMMON REVENUES INCOME SHARE ---------- ---------- - ---------- (Dollars in thousands except per share amounts) 1996 First quarter...........................$ 23,789 $ 663 $ 0.10 Second quarter.......................... 24,891 267 0.04 Third quarter........................... 26,351 537 0.08 Fourth quarter.......................... 25,214 (495) (0.07) 1997 First quarter...........................$ 26,308 $ (10,327) $ (1.49) Second quarter.......................... 28,151 538 0.08 Third quarter........................... 24,831 1,041 0.16 Fourth quarter.......................... 25,934 7,683 1.17
The second quarter of 1996 included nontaxable income of $343,000 for a settlement from a legal firm and a pretax charge for an arbitration award that was $1.1 million less than expected. The third quarter of 1996 included a credit to pretax income for the estimated recovery of certain litigation costs of $982,000 and a pretax charge of $1.0 million related to amounts recoverable from Midwest. The fourth quarter of 1996 included an additional pretax charge of $534,000 related to amounts recoverable from Midwest. Legal expenses related to the Midwest settlement and the CenTra litigation amounted to $875,000 in the fourth quarter of 1996. The first quarter of 1997 included a pretax charge of approximately $8.3 million ($8.5 million including provision for federal income tax) in connection with a jury verdict. In addition, the Company incurred litigation expenses of approximately $1.8 million in the first quarter of 1997 due primarily to the trial which began February 13, 1997. The Company also recorded approximately $315,000 in litigation expenses related to the conclusion of an arbitration proceeding in the first quarter of 1997. In the fourth quarter of 1997, the Company recorded the rescission of certain stock pursuant to an order issued on March 10, 1998 in the amount of $6,882,500. This amount was originally expensed as a part of the $8.3 million charge in the first quarter of 1997. Net litigation expenses were reduced by this amount in the fourth quarter of 1997 as a result of the order. Realized capital gains totaling approximately $728,000 before income taxes were recorded in the fourth quarter of 1997 as a result of NAICO shifting a portion of its fixed maturities portfolio from taxable to tax exempt bonds and NAICO's sale of Century Business Services, Inc. common stock. * * * * * * * PAGE F-27 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders of Chandler Insurance Company, Ltd.: We have audited the accompanying consolidated balance sheets of Chandler Insurance Company, Ltd. and subsidiaries (the "Company") as of December 31, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997 (all expressed in United States dollars). Our audits also included the financial statement schedules listed in the Index at Item 14. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Chandler Insurance Company, Ltd. and subsidiaries at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. As discussed in Note 10 to the consolidated financial statements, various legal proceedings included, among others: (a) on March 10, 1998 a court entered orders relating to judgments against the Company, and certain officers and/or directors regarding various claims and violations of securities laws. The parties to the litigation may appeal any or all of the orders of the court, and file motions for costs and fees related to the litigation; and (b) a shareholder, who is also a director of the Company, and certain affiliates with ownership or control of Company common shares have been ordered by a regulatory authority and a court to divest of all such common shares. Appeals to the court by such shareholders are currently pending. /s/ Deloitte & Touche DELOITTE & TOUCHE Grand Cayman, Cayman Islands March 23, 1998 PAGE F-28 SCHEDULE I CHANDLER INSURANCE COMPANY, LTD. AND SUBSIDIARIES SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES AS OF DECEMBER 31, 1997 (Dollars in thousands)
AMOUNT AT WHICH SHOWN IN THE FAIR BALANCE TYPE OF INVESTMENT COST VALUE SHEET - ----------------------------------------------------------------- - ---------- ---------- ----------- FIXED MATURITIES AVAILABLE FOR SALE: U.S. Treasury securities and obligations of U.S. government corporations and agencies........................ $ 41,208 $ 41,390 $ 41,390 Debt securities issued by foreign governments.................... 1,516 1,503 1,503 Obligations of states and political subdivisions................. 20,365 20,524 20,524 Corporate obligations............................................ 35,836 35,731 35,731 Public utilities................................................. 9,048 9,092 9,092 Mortgage-backed securities....................................... 3,449 3,478 3,478 - ---------- ---------- ----------- $ 111,422 $ 111,718 $ 111,718 - ---------- ---------- ----------- FIXED MATURITIES HELD TO MATURITY: U.S. Treasury securities and obligations of U.S. government corporations and agencies........................ $ 1,222 $ 1,330 $ 1,222 - ---------- ---------- ----------- EQUITY SECURITIES AVAILABLE FOR SALE: Corporate stock.................................................. $ - - $ 124 $ 124 - ---------- ---------- ----------- Total investments...................................................$ 112,644 $ 113,172 $ 113,064 ========== ========== ===========
PAGE F-29 SCHEDULE II CHANDLER INSURANCE COMPANY, LTD. AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT CHANDLER INSURANCE COMPANY, LTD. (PARENT COMPANY ONLY) BALANCE SHEETS (Dollars in thousands)
DECEMBER 31, - ----------------------- 1996 1997 ---------- - ---------- ASSETS Cash and cash equivalents...............................$ 16 $ 16 Investment in subsidiaries, net......................... 72,531 74,937 ---------- - ---------- Total assets............................................$ 72,547 $ 74,953 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities Litigation liabilities.............................$ - $ 16,618 ---------- - ---------- Total liabilities....................................... - 16,618 ---------- - ---------- Shareholders' equity Common stock, $1.67 par value, 10,000,000 shares authorized; 6,941,708 shares issued...... 11,593 11,593 Paid-in surplus.................................... 34,942 34,942 Capital redemption reserve......................... 947 947 Retained earnings.................................. 25,951 24,886 Unrealized gain (loss) on investments held by subsidiaries and available for sale, net of tax............................ (886) 253 Less: Stock held by subsidiary, at cost (494,617 shares)................................ - (2,487) Less: Stock rescinded through litigation (1,660,125 shares).............................. - (11,799) ---------- - ---------- Total shareholders' equity.............................. 72,547 58,335 ---------- - ---------- Total liabilities and shareholders' equity..............$ 72,547 $ 74,953 ========== ==========
PAGE F-30 SCHEDULE II CHANDLER INSURANCE COMPANY, LTD. AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT CHANDLER INSURANCE COMPANY, LTD. (PARENT COMPANY ONLY) STATEMENTS OF OPERATIONS (Dollars in thousands)
YEAR ENDED DECEMBER 31, - ------------------------------------ 1995 1996 1997 ---------- ---------- - ---------- Net investment income......................$ 2 $ - $ - Litigation expenses, net................... - - 4,819 ---------- ---------- - ---------- Income (loss) before equity in net income (loss) of subsidiaries........... 2 - (4,819) Equity in net income (loss) of subsidiaries......................... 3,776 972 3,754 ---------- ---------- - ---------- Net income (loss)..........................$ 3,778 $ 972 $ (1,065) ========== ========== ==========
PAGE F-31 SCHEDULE II CHANDLER INSURANCE COMPANY, LTD. AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT CHANDLER INSURANCE COMPANY, LTD. (PARENT COMPANY ONLY) STATEMENT OF CASH FLOWS (Dollars in thousands)
YEAR ENDED DECEMBER 31, - ------------------------------------ 1995 1996 1997 ---------- ---------- - ---------- Operating activities: Net income (loss).......................$ 3,778 $ 972 $ (1,065) Adjustments to reconcile net income (loss) to cash provided by operations: Net income of subsidiaries not distributed to parent............. (3,776) (972) (3,754) Net change in non-cash balances relating to operations: Litigation liabilities............ - - 4,819 ---------- ---------- - ---------- Cash provided by operations.......... 2 - - ---------- ---------- - ---------- Change in cash and cash equivalents during the year......................... 2 - - Cash and cash equivalents at beginning of year....................... 14 16 16 ---------- ---------- - ---------- Cash and cash equivalents at end of year...$ 16 $ 16 $ 16 ========== ========== ==========
PAGE F-32 SCHEDULE III CHANDLER INSURANCE COMPANY, LTD. AND SUBSIDIARIES SUPPLEMENTARY INSURANCE INFORMATION (Dollars in thousands)
FUTURE POLICY BENEFITS, OTHER DEFERRED LOSSES, POLICY POLICY CLAIMS CLAIMS AND ACQUISITION AND LOSS UNEARNED BENEFITS PREMIUM COSTS EXPENSES PREMIUMS PAYABLE REVENUE ------------ - ------------ ------------ ------------ ------------ Year ended December 31, 1995 Property-casualty............................$ 3,800 $ 128,794 $ 31,280 $ 4,484 $ 81,087 ============ ============ ============ ============ ============ Year ended December 31, 1996 Property-casualty............................$ 4,993 $ 79,639 $ 36,009 $ 4,016 $ 89,286 ============ ============ ============ ============ ============ Year ended December 31, 1997 Property-casualty............................$ 5,312 $ 74,929 $ 42,388 $ 4,830 $ 94,679 ============ ============ ============ ============ ============ AMORTIZATION NET CLAIMS, OF DEFERRED PREMIUMS NET LOSSES AND POLICY OTHER WRITTEN INVESTMENT SETTLEMENT ACQUISITION OPERATING AND INCOME EXPENSES COSTS EXPENSES ASSUMED ------------ - ------------ ------------ ------------ ------------ Year ended December 31, 1995 Property-casualty............................$ 8,053 $ 50,543 $ 23,995 $ 13,107 $ 84,640 ============ ============ ============ ============ ============ Year ended December 31, 1996 Property-casualty............................$ 7,339 $ 53,391 $ 32,123 $ 14,076 $ 93,715 ============ ============ ============ ============ ============ Year ended December 31, 1997 Property-casualty............................$ 8,017 $ 57,512 $ 28,145 $ 18,351 $ 96,866 ============ ============ ============ ============ ============
PAGE F-33 SCHEDULE IV CHANDLER INSURANCE COMPANY, LTD. AND SUBSIDIARIES REINSURANCE (Dollars in thousands)
ASSUMED PERCENTAGE CEDED TO FROM OF AMOUNT GROSS OTHER OTHER NET ASSUMED AMOUNT COMPANIES COMPANIES AMOUNT TO NET --------- --------- --------- --------- - ---------- Year ended December 31, 1995 Property-casualty......$ 95,520 $ 14,128 $ 3,248 $ 84,640 3.84% ========= ========= ========= ========= ========== Year ended December 31, 1996 Property-casualty......$ 103,801 $ 14,228 $ 4,142 $ 93,715 4.42% ========= ========= ========= ========= ========== Year ended December 31, 1997 Property-casualty......$ 123,014 $ 26,222 $ 74 $ 96,866 0.08% ========= ========= ========= ========= ==========
PAGE F-34 SCHEDULE V CHANDLER INSURANCE COMPANY, LTD. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS (In thousands)
BALANCE AT PROVISION BALANCE BEGINNING FOR AT END OF PERIOD NON-COLLECTION WRITE-OFFS OF PERIOD --------- -------------- ---------- - ---------- Allowance for non-collection of premiums receivable: 1995.....................$ 74 $ 124 $ (21) $ 177 ========= ============== ========== ========== 1996.....................$ 177 $ 1,768 $ (1,768) $ 177 ========= ============== ========== ========== 1997.....................$ 177 $ 52 $ (114) $ 115 ========= ============== ========== ========== Allowance for non-collection of reinsurance recoverables on paid and unpaid losses: 1995.....................$ 272 $ 440 $ (98) $ 614 ========= ============== ========== ========== 1996.....................$ 614 $ 2,078 $ (2,201) $ 491 ========= ============== ========== ========== 1997.....................$ 491 $ 527 $ (353) $ 665 ========= ============== ========== ==========
PAGE F-35 SCHEDULE VI CHANDLER INSURANCE COMPANY, LTD. AND SUBSIDIARIES SUPPLEMENTAL INFORMATION (FOR PROPERTY-CASUALTY INSURANCE UNDERWRITERS) (Dollars in thousands)
DISCOUNT PAID LOSSES DEDUCTED AND LOSS FROM ADJUSTMENT RESERVES EXPENSES ----------- - ----------- Year ended December 31, 1995 Property-casualty...............................$ - $ 67,049 =========== =========== Year ended December 31, 1996 Property-casualty...............................$ - $ 70,349 =========== =========== Year ended December 31, 1997 Property-casualty...............................$ - $ 59,052 =========== ===========
PAGE F-36 EXHIBIT 22.1 CHANDLER INSURANCE COMPANY, LTD. AND SUBSIDIARIES LIST OF ALL SUBSIDIARIES 1. Chandler Insurance (Barbados), Ltd., a Barbados company ("Chandler Barbados") that is a wholly owned subsidiary of the Company. 2. Chandler (U.S.A.), Inc., an Oklahoma corporation ("Chandler USA") that is a wholly owned subsidiary of Chandler Barbados. 3. LaGere & Walkingstick Insurance Agency, Inc., an Oklahoma corporation ("L&W") that is a wholly owned subsidiary of Chandler USA. 4. National American Insurance Company, a Nebraska corporation ("NAICO") that is a wholly owned subsidiary of Chandler USA. 5. Network Administrators, Inc., a Texas corporation ("Network") that is a wholly owned subsidiary of Chandler USA. 6. NAICO Indemnity (Cayman), Ltd., a Cayman Islands company ("NAICO Indemnity") that is a wholly owned subsidiary of the Company. 7. Chandler Insurance Management, Ltd., a Cayman Islands company ("CIM") that is a wholly owned subsidiary of the Company. 8. Chandler Insurance Management (Barbados), Ltd., a Barbados company ("CIM Barbados") that is a wholly owned subsidiary of the Company. 9. Windsor Acquisition Corporation, an Oklahoma corporation ("Windsor") that is a wholly owned subsidiary of Chandler Barbados. PAGE F-37 EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Post-Effective Amendment No. 3 to Form S-2 on Form S-8 Registration Statement No. 33-28436 of Chandler Insurance Company, Ltd. of our report dated March 23, 1998 (which expresses an unqualified opinion and includes an explanatory paragraph relating to litigation) appearing in the Annual Report on Form 10-K of Chandler Insurance Company, Ltd. for the year ended December 31, 1997. /s/ Deloitte & Touche DELOITTE & TOUCHE Grand Cayman, Cayman Islands March 27, 1998 EX-27 2
7 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CHANDLER INSURANCE COMPANY, LTD.'S DECEMBER 31, 1997 FORM 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS DEC-31-1997 JAN-01-1997 DEC-31-1997 111,718 1,222 1,330 124 0 0 113,064 11,999 3,069 5,312 210,790 74,929 42,388 4,830 0 2,796 0 0 11,593 46,742 210,790 94,679 8,017 764 2,528 57,512 28,145 18,351 1,216 2,281 (1,065) 0 0 0 (1,065) (0.16) (0.16) 65,207 53,704 3,808 22,214 36,838 64,053 3,808
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