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, 1999 and 2000, and the related consolidated statements of operations, comprehensive income, shareholder's equity and cash flows for each of the three years in the period ended December 31, 2000 have been audited by Deloitte & Touche LLP, independent auditors, whose independent auditors report expresses an unqualified opinion and includes an explanatory paragraph relating to litigation. The Balance Sheet Data at December 31, 1996 was derived from Chandler USA and its subsidiaries financial accounts; such accounts having been included in the consolidated financial statements of Chandler Insurance. The selected financial data should be read in conjunction with "LEGAL PROCEEDINGS," "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" and the consolidated financial statements of Chandler USA and the notes thereto appearing in Item 14(a). See Notes to Consolidated Financial Statements for various litigation and contingency matters.
Chandler USA is engaged in various property and casualty insurance operations through its wholly owned subsidiaries, NAICO and L&W. NAICO writes various property and casualty insurance products through four separate marketing programs: standard property and casualty, political subdivisions, surety bonds (including both bail bonds and construction bonds) and group accident and health. The lines of insurance written by NAICO are commercial coverages consisting of automobile liability, workers compensation, surety, automobile physical damage, accident and health, property, inland marine and other liability lines, which include general and professional liability lines. L&W represents various personal and commercial lines insurance companies in marketing property and casualty insurance. L&W also markets individual and group life, medical and disability income coverage. L&W places the majority of its business with NAICO. Business produced by L&W and placed with NAICO constituted approximately 23% of NAICO's direct premiums written and assumed in 2000.
Effective May 19, 2000, NAICO transferred its domicile from Nebraska to Oklahoma. NAICO's executive and administrative offices have been located in Chandler, Oklahoma since its acquisition by the Company in January 1987. As an Oklahoma corporation, NAICO and any person controlling NAICO, directly or indirectly, are subject to the insurance laws of Oklahoma including laws concerning the change or acquisition of control and payment of shareholder and policyholder dividends by NAICO.
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 when excess underwriting capacity exists. NAICO continues to experience pricing competition as the conditions of heightened price competition and impaired underwriting performance continue in the industry as a whole. However, NAICO was able to increase its pricing for most coverages during 2000.
Gross premiums earned, before reductions for premiums ceded to reinsurers, increased 8%, 21% and 25% in 1998, 1999 and 2000, respectively. The increases are primarily attributable to increases in premium production in Texas and Oklahoma, and to increases in premium rates during 2000. Net premiums earned, after such reductions, decreased 35% in 1998, increased 66% in 1999 and decreased 2% in 2000. The reduction in net premiums earned in 1998 was due primarily to the purchase of additional reinsurance for NAICO's workers compensation, casualty and nonstandard private-passenger automobile insurance programs. The rescission of two reinsurance treaties increased net premiums earned in 1999 by $19.6 million. During 2000, NAICO purchased additional reinsurance for its workers compensation and casualty lines of business which reduced NAICO's net retention for these lines of business and also reduced net premiums earned. Effective October 1, 2000, NAICO purchased quota share reinsurance which reduced NAICO's net retention for its casualty and workers compensation lines of business. The purchase of the quota share reinsurance reduced net premiums earned by $3.2 million in 2000.
Gross premiums earned in the political subdivisions program increased 17%, 20% and 15% in 1998, 1999 and 2000, respectively, due primarily to expansion of the school districts portion of the program in Texas and Missouri during 1998 and 1999, and to rate increases in the school districts portion of the program during 2000. Net premiums earned decreased 16% in 1998, increased 37% in 1999 and decreased 10% in 2000. The reduction in net premiums earned in 1998 was due primarily to the purchase of additional reinsurance in 1998. The rescission of the reinsurance treaties increased net premiums earned in 1999 by $2.3 million in this program. The purchase of the quota share reinsurance reduced net premiums earned in 2000 by $504,000 in this program.
Gross premiums earned in the group accident and health program increased 80% and 50% in 1998 and 1999, respectively, and decreased 63% in 2000. Net premiums earned increased 100% and 78% in 1998 and 1999, respectively, and decreased 61% in 2000. NAICO has discontinued this program.
Net interest income decreased 20% and 19% in 1998 and 1999, respectively, and increased 9% in 2000. The decrease in 1998 was due primarily to lower interest rates in 1998 and a reduction in invested assets due to the purchase of additional reinsurance in 1998. In addition, during the fourth quarter of 1997, NAICO shifted a portion of its fixed maturities portfolio from taxable to tax exempt bonds (which generally have a lower before-tax yield). In late 1998 and the first quarter of 1999, NAICO shifted approximately half of its investment in tax exempt bonds to taxable bonds. Net income from tax exempt securities was $1.0 million, $483,000 and $509,000 in 1998, 1999 and 2000, respectively. The decrease in net interest income in 1999 was due primarily to a reduction in invested assets due to the purchase of additional reinsurance. The increase in 2000 was due primarily to an increase in average invested assets and an increase in the average net yield on the portfolio. Net realized investment gains were $1.0 million, $57,000 and $144,000 in 1998, 1999 and 2000, respectively.
The average net yield on the portfolio, including net realized investment gains, was 5.9%, 4.3% and 4.5% in 1998, 1999 and 2000, respectively. The average net yield on the portfolio, excluding net realized investment gains, was 5.5%, 4.2% and 4.4% for 1998, 1999 and 2000, respectively. The decrease in the average net yield in 1999 was due primarily to an increase in 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, 2000 was approximately $14 million. The average yield on the portfolio before deducting investment expenses was 5.7%, 5.6% and 6.1% in 1998, 1999 and 2000, respectively, excluding capital gains.
During the fourth quarter of 1999, NAICO agreed to rescind two reinsurance treaties which covered a portion of its workers compensation business and which had been in effect since January 1, 1999. The reinsurer agreed to return the reinsurance premiums that had been paid by NAICO during 1999, less losses and ceding commissions that had been paid by the reinsurer. The reinsurer also agreed to pay NAICO a fee of $10.0 million as additional compensation for entering into the agreement.
L&W's brokerage commissions and fees before intercompany eliminations were $8.5 million in 1998, $9.6 million in 1999 and $9.4 million in 2000. A large portion of the brokerage commissions and fees for L&W is incurred by NAICO and thus eliminated in the consolidation of Chandler USA's subsidiaries.
L&W disposed of certain equipment in 1998 that resulted in a gain of approximately $145,000 which was included in other income.
The percentage of losses and loss adjustment expenses to net premiums earned ("loss ratio") was 68.8%, 78.8% and 76.0% in 1998, 1999 and 2000, respectively. The rescission of the reinsurance treaties increased losses and loss adjustment expenses in 1999 by $17.0 million. Excluding the effect of the reinsurance rescission, the loss ratio was 76.6% in 1999. Weather-related losses (net of applicable reinsurance) from wind and hail were $1.4 million, $4.3 million and $2.9 million in 1998, 1999 and 2000, respectively, and increased the respective loss ratios by 2.7, 6.4 and 3.4 percentage points (excluding the effect of the reinsurance rescission in 1999). The 1999 year included $1.8 million in weather-related losses which resulted from the tornadoes, strong winds and hail that caused significant damage in Oklahoma on May 3, 1999. The decrease in weather-related losses in 2000 was largely offset by adverse loss experience in the group accident and health program and higher than normal losses in Chandler USA's surety bond program.
General and administrative expenses were 8.8%, 7.0% and 6.5% of gross premiums earned and commissions, fees and other income (excluding the fee related to the rescission of the reinsurance treaties) in 1998, 1999 and 2000, respectively. General and administrative expenses have historically not varied in direct proportion to Chandler USA's revenues. A portion of such expenses is allocated to policy acquisition costs (indirect underwriting expenses) and loss and loss adjustment expenses based on various factors, including employee counts, salaries, occupancy and specific identification. Because certain types of expenses are fixed in nature, the percentage of such expenses to revenues will vary depending on Chandler USA's revenues.
Interest expense increased 101%, 69% and 51% in 1998, 1999 and 2000, respectively. The increase in 1998 was primarily due to increased levels of bank debt. The increases in 1999 and 2000 were due primarily to interest expense on the $24 million debenture offering which was completed on July 16, 1999 by Chandler USA. See "Liquidity and Capital Resources."
As a result of the factors described above, Chandler USA reported a net loss of $4.0 million and $87,000 in 2000 and 1999, respectively, compared to net income of $433,000 in 1998.
NAICO purchases fixed-maturity investments to support its investment strategies which are developed based on many factors including rate of return, maturity, credit risk, tax considerations, regulatory requirements and its mix of business. At the time of purchase, investments in debt securities that NAICO 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. NAICO 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 income tax as a separate component of other comprehensive income until realized.
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. At December 31, 2000, the total amount of cash and investments restricted as a result of these arrangements was $5.9 million.
The Nebraska Court had previously ordered CenTra to divest all shares of Chandler Insurance stock owned or controlled by it or its affiliates. During December 1999, Chandler Insurance acquired 1,989,200 shares of its own stock in exchange for payment of $15,204,758 to the CenTra Group and affiliates. During November 2000, Chandler Insurance acquired the remaining 1,142,625 of its common shares in exchange for payment of $6,882,500 to the CenTra Group and affiliates pursuant to a ruling of the Oklahoma Court in April 1997, which was upheld by the 10th Circuit Court of Appeals in September 2000. The Nebraska Court determined the method of divestiture of these shares and gave effect to the Oklahoma Court judgment ordering the repurchase of the shares which resulted in the above payments. Based on the April 1997 judgment and subsequent actions by the Oklahoma Court, Chandler Insurance previously recorded the return of 1,660,125 shares as a decrease to shareholders' equity during 1997. Following the execution of the judgment of the Nebraska Court, the CenTra Group filed pleadings in the Oklahoma Court claiming entitlement to post-judgment interest on the amounts Chandler Insurance was ordered to pay in exchange for the transfer of the shares. CenTra claims that it is entitled to post-judgment interest amounting to approximately $2.5 million. Chandler Insurance vigorously opposes this claim and the issue is now pending before the Oklahoma Court. The Oklahoma Court has asked for briefs and may hear argument but has not scheduled a date for decision of these issues. The Oklahoma Court currently has under consideration dispositive motions regarding a claim made by CenTra affiliates based upon alleged wrongful cancellation of certain insurance policies by NAICO and NAICO Indemnity (Cayman), Ltd., a wholly owned subsidiary of Chandler Insurance.