The selected financial data has been derived from the consolidated financial statements of Chandler USA and its subsidiaries, which appear in Item 14(a). The consolidated balance sheets of Chandler USA and its subsidiaries as of December 31, 2000, and the related consolidated statement of operations, comprehensive income, shareholder's equity and cash flows for the years ended December 31, 2000 were audited by Deloitte & Touche LLP, independent auditors, whose independent auditors' report expressed an unqualified opinion and included an explanatory paragraph relating to litigation. The consolidated balance sheets of Chandler USA and its subsidiaries as of December 31, 2001 and 2002 and the related consolidated statements of operations, comprehensive income, shareholder's equity and cash flows for the years ended December 31, 2001 and 2002 have been audited by Tullius Taylor Sartain & Sartain LLP, independent auditors, whose independent auditors' report expresses an unqualified opinion. The selected financial data should be read in conjunction with "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" and the consolidated financial statements of Chandler USA and the notes thereto appearing in Item 14(a). All periods have been restated to reflect the results of L&W as a discontinued operation.
Chandler USA is engaged in various property and casualty insurance operations through its wholly owned subsidiaries, NAICO and CIMI. NAICO writes various property and casualty insurance products through three separate marketing programs: standard property and casualty, political subdivisions and surety bonds (including both bail bonds and construction bonds). The lines of insurance written by NAICO are commercial coverages consisting of automobile liability, workers compensation, surety, automobile physical damage, property, inland marine and other liability lines, which include general and professional liability lines. CIMI maintains certain wholesale operations related to NAICO's school districts and trucking programs.
Reinsurance recoverables on unpaid losses and loss adjustment expenses are similarly subject to changes in estimates and assumptions. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policies. In addition to factors noted above, estimates of reinsurance recoverables may prove uncollectible if the reinsurer is unable or unwilling to meet its responsibilities under the reinsurance contracts. Reinsurance contracts do not relieve an insurer from its obligation to policyholders.
The impact of a recession on Chandler USA would depend on its duration and severity. A prolonged downturn in the economy could result in decreased demand for NAICO's insurance products and an increase in uncollectible premiums and/or reinsurance recoverables. In addition, an economic downturn could result in an increase in the number of insurance claims if insureds decrease expenditures that promote safety. Much of NAICO's insurance business is concentrated in the Southwest and Midwest areas of the United States. Approximately $127 million, or 90%, of NAICO's direct written premiums in 2002 were in the states of Oklahoma and Texas. An economic downturn in these states could have a significant adverse impact on Chandler USA. A recession might also cause defaults on fixed-income securities owned by NAICO. During 2002, the market value of NAICO's available for sale investments increased by $2.8 million due primarily to lower interest rates experienced during this time. Management believes it has mitigated the impact of a recession by employing conservative underwriting practices and strict credit policies and maintaining a high- quality investment portfolio.
On December 20, 2002, Chandler USA completed the sale of its wholly owned subsidiary L&W to Brown & Brown, Inc. for $3,247,000 in cash and a $361,000 note receivable that is due on or before December 31, 2003. Chandler USA recorded an after-tax gain of $671,000 on the sale based on the minimum purchase price for the transaction, after deducting Chandler USA's goodwill related to L&W of $2,350,000, equity in L&W of $224,000 and approximately $400,000 of expenses in connection with the sale. The gain on the sale may be increased over the next three years depending on certain adjustments to the purchase price as defined in the terms of the transaction, with a maximum purchase price of $6.0 million. The transaction was effective December 1, 2002.
L&W is expected to continue to be a significant producer of business for NAICO. Retail business produced by L&W and placed with NAICO constituted approximately 8% of NAICO's direct premiums written and assumed in 2002. Chandler USA will maintain certain wholesale operations related to NAICO's school districts and trucking programs through CIMI, an underwriting manager that was established in December 2002. L&W previously functioned as Chandler USA's agency segment and is presented as discontinued operations.
Chandler USA agreed to indemnify Brown & Brown, Inc. for any breach of a representation, warranty or covenant made in connection with the sale for a period of three years, and has deposited cash in the amount of $500,000 into a trust account for the benefit of Brown & Brown, Inc. as security. Prior to completing the sale, L&W transferred its real estate to NAICO, and transferred substantially all of its remaining assets and liabilities, primarily premiums receivable and premiums payable, to Chandler USA through a shareholder dividend.
Net realized investment gains were $144,000, $2,654,000 and $794,000 in 2000, 2001 and 2002, respectively. The net realized investment gains in 2001 and 2002 resulted primarily from sales of fixed maturity investments available for sale to provide cash for operating activities due to the decrease in written premiums.
The average net yield on the portfolio, including net realized investment gains, was 4.5%, 7.7% and 4.8% in 2000, 2001 and 2002, respectively. The average net yield on the portfolio, excluding net realized investment gains, was 4.3%, 4.4% and 3.7% for 2000, 2001 and 2002, respectively. Chandler USA excludes interest income from related parties when calculating its average net yield on the portfolio. Chandler USA's average net yield has been reduced by investment expenses to subsidize a premium finance program for certain insureds of NAICO. While such expenses reduce Chandler USA's average net yield, the premium finance program enhances cash flow by providing cash which is available for investment earlier than conventional deferred payment plans. Based on information provided by the premium finance company, the outstanding balance of premiums financed at December 31, 2002 was approximately $11 million. The average yield on the portfolio before deducting investment expenses was 6.1%, 5.9% and 4.4% in 2000, 2001 and 2002, respectively, excluding capital gains.
The percentage of losses and loss adjustment expenses to net premiums earned ("loss ratio") was 76.0%, 75.1% and 75.7% in 2000, 2001 and 2002, respectively. Weather-related losses (net of applicable reinsurance) from wind and hail were $2.9 million, $2.0 million and $1.5 million in 2000, 2001 and 2002, respectively, and increased the respective loss ratios by 3.4, 2.9 and 2.2 percentage points. During 2001, the decline in weather-related losses and increases in premium rates resulted in improved loss ratios for the standard property and casualty and political subdivisions programs for the 2001 accident year. However, these improvements were offset by adverse loss development experienced during 2001 related to prior accident years totaling $12.7 million. This adverse loss development was due primarily to increased loss severity in the standard property and casualty and political subdivisions programs. A substantial part of this loss development was for workers compensation losses in the 1999 accident year. NAICO's net retention for workers compensation losses increased substantially in 1999 due to the rescission of certain reinsurance treaties covering this line of business. Also contributing to the adverse loss development were provisions for potentially uncollectible reinsurance and deductibles of approximately $1.2 million during 2001, an increase in losses in the surety bond program and approximately $878,000 in losses for the runoff of the discontinued group accident and health program.
The following table sets forth Chandler USA's policy acquisition costs from continuing operations for each of the three years ended December 31, 2000, 2001 and 2002:
Total gross direct and indirect expenses as a percentage of direct written and assumed premiums were 23.4%, 23.7% and 23.8% in 2000, 2001 and 2002, respectively. For these periods, commission expense as a percentage of gross written and assumed premiums was 15.6%, 14.6% and 14.4%. Indirect underwriting expenses were 4.6%, 5.7% and 5.8% of total direct written and assumed premiums in 2000, 2001 and 2002, respectively. Indirect expenses include general overhead and administrative costs associated with the acquisition of new and renewal business, some of which is relatively fixed in nature, thus, the percentage of such expenses to direct written and assumed premiums will vary depending on Chandler USA's overall premium volume. Premium taxes decreased $1.5 million in 2002 due to the decrease in written premiums, a decrease in expenses associated with guaranty fund assessments and the elimination of a 2% tax on workers compensation premiums written in Oklahoma. However, an increase in premium related assessments in Oklahoma offset part of this savings. Expenses associated with guaranty fund assessments, net of applicable premium tax credits, were approximately $252,000, $489,000 and $31,000 in 2000, 2001 and 2002, respectively. NAICO may receive additional guaranty fund assessments in the future related to Reliance or other insolvent insurance companies. At this time, NAICO is unable to estimate the amount of such assessments.
Commissions received from reinsurers included $3.4 million, $4.6 million and $744,000 in 2000, 2001 and 2002, respectively, for the quota share reinsurance purchased in the fourth quarter of 2000. Net policy acquisition costs decreased $1.5 million, $4.9 million and $2.3 million in 2000, 2001 and 2002, respectively, due to the purchase of the quota share reinsurance, net of the adjustment for deferred acquisition costs.
Interest expense decreased less than 1% in 2001 and 2002. Substantially all of Chandler USA's interest expense is related to the $24 million of outstanding debentures. See "Liquidity and Capital Resources."
During 2000, Chandler USA provided $10.7 million in cash from operations. During 2001, Chandler USA used $27.8 million in cash from operations due primarily to decreases in unpaid losses and loss adjustment expenses, unearned premiums and premiums payable that resulted from the decrease in written premiums in 2001, and from the payment of claims for prior years. During 2002, Chandler USA used $7.5 million in cash from operations due primarily to a decrease in premiums payable that resulted from the reduction in reinsurance premiums ceded.
Reinsurance contracts do not relieve an insurer from its obligation to policyholders. Failure of reinsurers to honor their obligations could result in losses to Chandler USA; consequently, adjustments to ceded losses and loss adjustment expenses are made for amounts deemed uncollectible. NAICO did not incur any charges for uncollectible reinsurance recoverables from reinsurers in 2000. During 2001 and 2002, NAICO incurred charges of $454,000 and $1.7 million, respectively, in adjustments to ceded losses and loss adjustment expenses for amounts deemed uncollectible.
Transamerica reinsured NAICO for certain workers compensation risks during 1989, 1990 and 1991. Beginning in 1996, Transamerica refused to pay NAICO for balances that it owed under the reinsurance treaties. Transamerica owed NAICO approximately $1.5 million for reinsurance recoverables on paid losses and loss adjustment expenses as of December 31, 2002. NAICO is currently engaged in arbitration in order to enforce the terms of the reinsurance treaties.
See Note 1 to Consolidated Financial Statements for a discussion of recently issued accounting pronouncements.