Chandler USA and its subsidiaries own and occupy four office buildings with approximately 127,000 square feet of usable space in Chandler, Oklahoma. Chandler USA's subsidiaries also lease approximately 1,500 square feet in the aggregate for its branch offices. Chandler USA believes such space is sufficient for its operations for the foreseeable future.
The preparation of financial statements in conformity with GAAP requires the application of accounting policies that often involve a significant degree of judgment. Management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods. If management determines, as a result of its consideration of facts and circumstances, that changes in estimates and assumptions are appropriate, results of operations and financial position as reported in the consolidated financial statements may change significantly. Management has identified the following accounting policies as critical in understanding Chandler USA's reported financial results:
A company's capacity to write insurance policies is dependent on a variety of factors including its net worth or "surplus," the lines of business written, the types of risk insured and its profitability. Since the late 1980's, the industry has generally had excess underwriting capacity. This condition resulted in depressed premium rates and expanded policy terms, which generally occur when excess underwriting capacity exists. NAICO continues to experience competition, however, NAICO was able to increase its pricing for most coverages during 2001 and 2002, which has generally been the trend industry wide. NAICO's underwriting philosophy is to forego underwriting risks from which it is unable to obtain what it believes to be adequate premium rates.
Gross premiums earned decreased 10% and 15% in 2001 and 2002, respectively, as NAICO focused on improving underwriting profitability in its core programs by re-underwriting and re-pricing the business and discontinuing certain classes of business. Increases in premium rates partially offset the decrease in premium production. Net premiums earned decreased 18% and 4% in 2001 and 2002, respectively. Effective October 1, 2000, NAICO purchased quota share reinsurance which reduced NAICO's net retention for its casualty and workers compensation lines of business and also reduced net premiums earned. This quota share reinsurance expired effective January 1, 2002 and NAICO elected not to renew it. The quota share reinsurance reduced net premiums earned by $3.2 million, $11.3 million and $4.6 million in 2000, 2001 and 2002, respectively.
Gross premiums earned in the standard property and casualty program decreased 8% and 18% in 2001 and 2002, respectively. The decreases in 2001 and 2002 were due primarily to discontinuing certain accounts and classes of business where rates were not believed to be adequate. Increases in premium rates partially offset the decrease in premium production. Gross premiums earned in Texas decreased $4.2 million and $13.7 million in 2001 and 2002, respectively, and gross premiums earned in Oklahoma decreased $6.9 million and $7.2 million in 2001 and 2002, respectively. Net premiums earned decreased 15% and 7% in 2001 and 2002, respectively. The quota share reinsurance reduced net premiums earned by $2.7 million, $9.5 million and $3.8 million in this program in 2000, 2001 and 2002, respectively.
Gross premiums earned in the political subdivisions program decreased 1% in 2001 and increased 3% in 2002. Gross premiums earned in the school districts portion of the program increased $1.2 million and $4.5 million in 2001 and 2002, respectively, due primarily to increased premium rates in Oklahoma. This was largely offset by a decrease in gross premiums earned for the municipalities portion of the program. Net premiums earned decreased 2% in 2001 and increased 10% in 2002. The quota share reinsurance reduced net premiums earned by $504,000, $1.8 million and $835,000 in this program in 2000, 2001 and 2002, respectively.
Gross premiums earned in the surety bond program decreased 36% and 42% in 2001 and 2002, respectively. The decreases are primarily due to stricter underwriting policies and a reduction in the number of appointed agents that produce this business as NAICO focuses on improving underwriting profitability in this program. Net premiums earned in the surety bond program decreased 36% and 20% in 2001 and 2002, respectively.
At December 31, 2002, Chandler USA's investment portfolio consisted primarily of fixed income U.S. Government and high-quality corporate bonds, with approximately 14% invested in cash and money market instruments. Income generated from this portfolio is largely dependent upon prevailing levels of interest rates. Chandler USA's portfolio contains no non-investment grade bonds or real estate investments. Chandler USA also receives interest income from Chandler Barbados on intercompany loans.
Net interest income from continuing operations, excluding interest income from Chandler Barbados, decreased 15% and 30% in 2001 and 2002, respectively. The decreases in 2001 and 2002 were due primarily to lower interest rates and a reduction in invested assets. Cash and invested assets decreased from $104.8 million at December 31, 2000 to $73.4 million and $68.3 million at December 31, 2001 and 2002, respectively. This decrease resulted primarily from the reduction in premiums written during 2001 and 2002, the payment of claims for prior years and an increase in intercompany loans to Chandler Barbados. The increase in intercompany loans during 2001 was primarily to provide financing for a going private transaction for Chandler Insurance. Interest income from Chandler Barbados was $371,000 and $380,000 during 2001 and 2002, respectively. Chandler USA did not have any interest income from Chandler Barbados during 2000. See Liquidity and Capital Resources.
As a result of the factors described above, Chandler USA reported a loss from continuing operations of $3.1 million, $481,000 and $3.0 million in 2000, 2001 and 2002, respectively, and a net loss of $4.0 million, $1.1 million and $2.1 million in 2000, 2001 and 2002, respectively.
Cash flows from investing activities were primarily the result of normal purchases and sales of investment securities. Net realized investment gains before income taxes were $144,000, $2,654,000 and $794,000 during 2000, 2001 and 2002, respectively, from the sale of investments. NAICO received proceeds of $14.2 million, $73.1 million and $31.5 million during 2000, 2001 and 2002, respectively, from the sale of available for sale fixed-income securities prior to their maturity. The proceeds and related net realized investment gains in 2001 and 2002 provided cash for operating activities due to the decrease in written premiums. The average maturity of NAICO's investments was 3.3 years and 3.1 years at December 31, 2001 and 2002, respectively. Cash flows from investing activities also included $3.8 million from a sale and leaseback transaction for certain equipment owned by Chandler USA during 2001. The sale and leaseback transaction resulted in a reduction of property and equipment of $1.8 million and a deferred gain of $2.0 million which is included in accrued taxes and other payables. Chandler USA has exercised its option to repurchase the equipment at the end of the lease for approximately $3.0 million and will amortize the deferred gain into income over the last year of the lease. See Note 11 to Consolidated Financial Statements. Cash flows from investing activities also included proceeds from the sale of L&W in 2002 of $3.1 million net of cash disposed of as part of the sale. See Note 4 to Consolidated Financial Statements for more information.
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. Chandler USA has deposited cash into a trust account as security related to certain indemnification provisions related to its sale of L&W. At December 31, 2002, the total amount of cash and investments restricted as a result of these arrangements was $8.0 million.
During 2001, Chandler USA and Chandler Barbados entered into an Intercompany Credit Agreement (the "Credit Agreement") covering intercompany loans between the parties. The Credit Agreement requires interest to be paid at the prime interest rate published in The Wall Street Journal each month, and balances owed by either party are payable at any time upon demand. At December 31, 2001 and 2002, Chandler Barbados owed approximately $7.9 million and $10.6 million, respectively, to Chandler USA, and Chandler USA earned $371,000 and $380,000 in interest income from Chandler Barbados during 2001 and 2002, respectively.
Chandler Insurance and certain of its subsidiaries and affiliates, including Chandler USA, were previously involved in various matters of litigation with CenTra, Inc. ("CenTra"). In the CenTra litigation, certain officers and directors of Chandler USA and Chandler Insurance were named as defendants. In accordance with its Articles of Association, Chandler Insurance and its subsidiaries have 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. These expenses together with certain other expenses may be recovered from Chandler Insurance's director and officer liability insurance policy (the "D&O Insurer"). As a result of various events in 1995, 1996 and 1997, Chandler Barbados and Chandler USA recorded estimated recoveries of costs from its D&O Insurer totaling $3,456,000 and $1,044,000, respectively, for reimbursable amounts previously paid that relate to allowable defense and litigation costs for such parties. Chandler Barbados and Chandler USA received payment for a 1995 claim during 1996 in the amount of $636,000 and $159,000, respectively. The balance of $2,820,000 and $885,000 is included in other assets in Chandler Barbados' and Chandler USA's respective balance sheets. Chandler Insurance and its subsidiaries contend they are entitled to a total of $5 million under the applicable insurance policy to the extent they have advanced reimbursable expenses. The D&O Insurer contends that certain policy provisions exclude coverage for these claims. On August 22, 2001, Chandler Insurance and its subsidiaries, including Chandler USA, filed an action in the State District Court in Oklahoma City, Oklahoma ("Oklahoma State Court") alleging that the director and officer liability insurance policies should be rescinded and seeking repayment of more than $5 million in premiums they previously paid. Chandler Insurance and its subsidiaries are currently involved in litigation with the insurer for payment of the policy balance or rescission and repayment of premiums previously paid. The litigation is pending in the Oklahoma State Court. The case is still in the early pleading stages and Chandler USA cannot predict the date of resolution or the outcome of this case. Chandler Insurance and its subsidiaries may or may not recover the remaining policy limits or the previously paid premiums and could incur significant costs in resolving this matter.