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 2,300 square feet in the aggregate for its branch offices. Chandler USA believes such space is sufficient for its operations for the foreseeable future.
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 cleanup 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.
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 $175 million, or 89%, of NAICO's direct written premiums in 2000 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. 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.
Gross premiums earned in the standard property and casualty program increased 22%, 30% and 40% 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 decreased 35% in 1998, increased 94% in 1999 and increased 11% 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 $17.3 million in this program. The increase in net premiums earned in 2000 was partially offset by the purchase of the quota share reinsurance which reduced net premiums earned in 2000 by $2.7 million in this program.
Gross premiums earned in the surety bond program decreased 3% in 1998, increased 15% in 1999 and increased less than 1% in 2000. Approximately $1.3 million of the gross premiums earned in 2000 relates to a new program that is 100% reinsured by an unaffiliated reinsurer. Excluding this new program, gross premiums earned decreased $1.3 million in 2000. NAICO discontinued this new program effective January 1, 2001. The decrease in 2000 was due primarily to decreased written premium production in California. Net premiums earned in the surety bond program decreased 29% in 1998, increased 5% in 1999 and decreased 17% in 2000.
At December 31, 2000, Chandler USA's investment portfolio consisted primarily of fixed income U.S. Government, high-quality corporate and tax exempt bonds, with approximately 11% 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's income from commissions, fees and other income decreased 26%, 15% and 5% for 1998, 1999 and 2000, respectively. The majority of Chandler USA's income from commissions, fees and other income are from L&W.
The following table sets forth Chandler USA's policy acquisition costs for each of the three years ended December 31, 1998, 1999 and 2000:
Total gross direct and indirect expenses as a percentage of direct written and assumed premiums were 25.2%, 24.8% and 23.6% in 1998, 1999 and 2000, respectively. For these periods, commission expense as a percentage of gross written and assumed premiums was 11.5%, 12.1% and 11.6%. Indirect underwriting expenses were 10.3%, 9.6% and 8.9% of total direct written and assumed premiums in 1998, 1999 and 2000, 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 increased $1.3 million in 2000 due to the increase in written premiums and to a refund of $392,000 which was received in 1999 for premium taxes paid in a prior year.
Commissions received from reinsurers was reduced by $9.7 million during 1999 due to the rescission of the reinsurance treaties discussed previously. Net policy acquisition costs increased $7.0 million in 1999 due to the rescission of the reinsurance treaties, net of the adjustment for deferred acquisition costs. Ceding commissions during 2000 included $3.4 million for the purchase of the quota share reinsurance in the fourth quarter of 2000. Net policy acquisition costs decreased $1.5 million in 2000 due to the purchase of the quota share reinsurance, net of the adjustment for deferred acquisition costs.
Litigation expenses reflect expenses related to the ongoing legal proceedings involving the CenTra Group. Litigation expenses were $423,000 in 1998 compared to $207,000 in 1999 and $71,000 in 2000. Increased or renewed activity could result in greater litigation expenses in the future.
NAICO maintains a liquid operating position and follows 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.
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 $1.0 million, $57,000 and $144,000 during 1998, 1999 and 2000, respectively, from the sale of investments. In addition, NAICO received proceeds of $36.2 million, $4.2 million and $14.2 million during 1998, 1999 and 2000, respectively, from the sale of available for sale fixed-income securities prior to their maturity. In 1998, to augment maturities and reposition its portfolio, NAICO chose to liquidate certain fixed maturity securities that were available for sale prior to their maturities. The average maturity of NAICO's investments was 4.0 years and 4.6 years at December 31, 1999 and 2000, respectively.
Chandler Insurance will finance the Recapitalization Plan through (i) a $2.4 million sale of Chandler Insurance Class A Common Shares to Messrs. LaGere and Paden, (ii) up to an $11.8 million intercompany loan from Chandler Barbados, and (iii) proceeds of approximately $735,000 from the exercise of outstanding Chandler Insurance options. Chandler USA will loan up to $11.8 million to Chandler Barbados. Up to $8.0 million of Chandler USA's intercompany loan to Chandler Barbados will be from a dividend declared by NAICO and approximately $3.8 million will be from a sale and leaseback transaction for certain equipment owned by Chandler USA. Management believes that the use of the intercompany loan will not impair the financial position of Chandler Insurance, Chandler USA or its subsidiaries.
In 1992, Chandler Insurance and certain of its subsidiaries and affiliates became involved in certain legal proceedings beyond the ordinary course of business. See Note 9 to Consolidated Financial Statements for a detailed discussion of the CenTra litigation.
Through 2000, Chandler USA has not experienced any significant problems or disruptions related to year 2000 problems. Chandler USA is currently not aware of any significant disruptions experienced by its customers, vendors and service providers that would materially affect their ability to do business with Chandler USA. While it is possible that certain year 2000 problems may exist but have not yet materialized, Chandler USA does not currently expect any year 2000 problems to be encountered in the future that would have a material adverse effect on the operating results of Chandler USA.
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. SFAS No. 133, as amended, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that Chandler USA recognize all derivatives as either assets or liabilities in the statement of financial condition and measure those instruments at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. Chandler USA will adopt SFAS No. 133 effective January 1, 2001. The adoption of SFAS No. 133 will not have a material impact on Chandler USA's consolidated financial condition, results of operations or cash flows since Chandler USA has no derivative instruments.