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 two separate marketing programs: standard lines and political subdivisions. The lines of insurance written by NAICO are commercial coverages consisting of workers compensation, automobile liability, other liability (including general liability, products liability and umbrella liability), automobile physical damage, property, surety and inland marine. During 2005, NAICO began writing homeowner and dwelling fire and allied lines policies in the state of Texas through a managing general agent. NAICO discontinued its homeowners program during 2006. NAICO also transferred its property and inland marine business for the standard lines and political subdivisions programs to Praetorian effective January 1, 2007 through an arrangement between Praetorian and CIMI. CIMI and Praetorian terminated this arrangement effective June 29, 2009. Effective July 1, 2009, the property, inland marine, automobile liability, automobile physical damage and other liability lines of insurance in NAICO's political subdivisions program are being written by Greenwich through an arrangement with CIMI. See "Insurance Programs" for more information. NAICO markets these products through a network of independent insurance agents. A portion of the insurance written by NAICO is reinsured by Chandler USA's parent Chandler Insurance. CIMI is an underwriting manager and wholesaler that offers multiple insurance products for businesses in various industries and political subdivisions.
For the year ended December 31, 2009, Chandler USA had net income of $2.2 million compared to $525,000 for 2008 and a net loss of $662,000 for 2007. The net loss in 2007 was primarily due to the reversal of a portion of the prejudgment interest income that was accrued during 2006 on a favorable jury verdict. This is discussed in more detail under "Litigation" and in Note 11 to Consolidated Financial Statements.
NAICO periodically reviews the reserve estimates relating to insurance business written or assumed by NAICO and the methods used to arrive at such reserve estimates. NAICO also retains independent professional actuaries who review such reserve estimates and methods. Methods used include the paid loss development method, incurred loss development method, Bornhuetter- Ferguson method and loss ratio method. Most methods assume that past patterns in the historical data will be repeated in the future, as long as there are no significant changes in pertinent variables. The methods chosen are those that are believed to produce the most reliable indication at that particular evaluation date. While each of the methods produce point estimates for each period analyzed, management's best estimate is usually comprised of a combination of methods due to differences in conditions during each period. The selected estimate may be one method, or a weighted average of several methods, or a judgmental selection if management determines it is appropriate. The ultimate point estimate selected by management represents the amount that management believes is the most likely amount that will ultimately be paid to settle the net reserves recorded at a particular point in time.
The following table shows the recorded reserves and the high and low point estimates based on the results of the various actuarial methods described above as of December 31, 2009.
The estimation methods chosen are those that are believed to produce the most reliable indication at that particular evaluation date for the losses being evaluated. The actuarial methods used in the 2009 loss reserve analysis were similar to those used in the 2008 analysis. During 2008, NAICO modified the way that the loss data was grouped for analysis purposes so that the data could be analyzed by line of business rather than by insurance program. Management believes that by doing so, the analysis is enhanced since each line of business may produce different loss development trend patterns.
In addition, at December 31, 2009, Chandler USA had net operating loss carryforwards available for Oklahoma state income taxes totaling approximately $33.9 million which expire in the years 2010 through 2029. A valuation allowance has been provided for the tax effect of the state net operating loss since realization of such amount is not considered more likely than not.
Net premiums earned decreased 3% in 2008 and 12% in 2009. During 2008, net premiums earned increased for the workers compensation and other liability lines of insurance, but decreased for automobile liability due to the decrease in gross premiums earned. During 2009, net premiums earned increased slightly in the workers compensation line of business, but decreased in the automobile liability and other liability lines of business due to the decrease in gross premiums earned.
Gross premiums earned in the standard lines program decreased 4% in 2008 and 10% in 2009. Gross premiums earned for workers compensation business in this program increased $3.7 million or 13% in 2008, and $651,000 or 2% in 2009. Gross premiums earned from trucking accounts decreased $8.2 million in 2008 and $6.2 million in 2009. Net premiums earned in the standard lines program decreased 2% in 2008 and 11% in 2009. Net premiums earned from trucking accounts decreased $4.6 million in 2008 and $4.2 million in 2009.
At December 31, 2009, Chandler USA's investment portfolio consisted primarily of fixed income U.S. Treasury and government agency bonds, high- quality corporate and tax exempt bonds and certificates of deposit insured by the FDIC, with approximately 7% 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 related parties on intercompany loans. During 2007, NAICO reversed $4.1 million of prejudgment interest income based on a final judgment entered by the court. The prejudgment interest income had been accrued during 2006 on a favorable jury verdict in civil litigation regarding certain surety bond claims in 2006. See Litigation and Note 11 of Notes to Consolidated Financial Statements.
The average net yield on the fixed maturity portfolio, including net realized investment gains, was 4.0%, 3.4% and 4.3% in 2007, 2008 and 2009, respectively. The average net yield on the fixed maturity portfolio, excluding net realized investment gains, was 3.8% for 2007, 3.3% for 2008 and 2.9% for 2009. 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, 2009 was approximately $12.1 million. The average yield on the fixed maturity portfolio before deducting investment expenses was 4.2% in 2007, 3.6% in 2008 and 3.1% in 2009, excluding net realized capital gains.
During 2009, NAICO experienced adverse loss development totaling $734,000 primarily in the workers compensation line of business in the standard lines program. A portion of the adverse loss development was offset by favorable development in the automobile liability and other liability lines of business in this program. The adverse loss development included approximately $180,000 for provisions for potentially uncollectible reinsurance.
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. During 2007, 2008 and 2009, NAICO incurred charges of $356,000, $166,000 and $180,000, respectively, in adjustments to ceded losses and loss adjustment expenses for amounts deemed uncollectible.
The following table sets forth Chandler USA's policy acquisition costs for each of the three years ended December 31, 2007, 2008 and 2009:
Total gross direct and indirect expenses as a percentage of direct written and assumed premiums were 24.0% in 2007, 24.6% in 2008 and 25.5% in 2009. For these periods, commissions expense as a percentage of gross written and assumed premiums was 14.0%, 14.3% and 14.8%.
Indirect underwriting expenses as a percentage of direct written and assumed premiums were 5.9% in 2007 and 6.4% in 2008 and 2009, respectively. The increase in indirect underwriting expenses during 2008 was primarily due to increased marketing costs. 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. Commissions received from reinsurers as a percentage of ceded reinsurance premiums were 31.4%, 32.4% and 31.7% in 2007, 2008 and 2009, respectively.
Interest expense decreased 5.0% in 2008 and 8.3% in 2009. Substantially all of Chandler USA's interest expense is related to its outstanding senior debentures and junior subordinated debentures. The decreases in 2008 and 2009 were due primarily to the decrease in interest rates during these periods, as a portion of Chandler USA's junior subordinated debentures were issued with a floating interest rate.
Chandler USA's federal income tax benefit (provision) as a percentage of income (loss) before income taxes was 11.6%, 56.4% and 37.3% for 2007, 2008 and 2009, respectively. The 2007 percentage was lower than the percentage expected using U.S. Federal enacted income tax rates due primarily to the impact of nondeductible expenses on the net loss before income taxes. The 2008 and 2009 percentages were higher than the percentage expected due primarily to the impact of nondeductible expenses on net income before income taxes.
A significant portion of Chandler USA's consolidated assets represents assets of NAICO that may not be immediately transferable to Chandler USA in the form of shareholder dividends, loans, advances or other payments.
Historically, NAICO has played a significant role in the servicing of debt and other obligations of Chandler USA through the payment of shareholder dividends. These obligations include $7.0 million of 8.75% senior debentures due in 2014, $13.4 million of 9.75% junior subordinated debentures due in 2033, $7.2 million of floating rate junior subordinated debentures due in 2034 and the obligations under the sale and leaseback transaction discussed below. To the extent that the restrictions discussed previously limit NAICO's ability to pay shareholder dividends or other payments to Chandler USA, Chandler USA's ability to satisfy the debt obligations may also be limited.
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. At December 31, 2009, approximately 96% of total fixed maturity investments were rated AA or better by Moody's Investor Service, Inc. or Standard & Poor's. Approximately 3% of total fixed maturities were rated A by Moody's Investor Service, Inc. or Standard & Poor's, and approximately 1% was rated BAA by Moody's Investor Service, Inc. and BBB by Standard & Poor's.
NAICO purchases 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. As of December 31, 2009, all of the investments of NAICO were in fixed- maturity investments, certificates of deposit insured by the FDIC, interest- bearing money market accounts, collateralized repurchase agreements and common stock received in connection with an unaffiliated entity's conversion to a for-profit corporation. 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. Debt securities not classified as held to maturity or trading and equity securities are classified as available for sale, with the related unrealized gains and losses excluded from earnings and reported net of deferred income tax as a separate component of other comprehensive income until realized.
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 $214,000, $95,000 and $1,527,000 during 2007, 2008 and 2009, respectively, from the sale of investments. NAICO received proceeds of $17.6 million, $6.7 million and $30.1 million during 2007, 2008 and 2009, respectively, from the sale of available for sale securities prior to their maturity. The market value of NAICO's available for sale fixed- income investments increased $2.2 million and $1.9 million in 2007 and 2008 and decreased $532,000 in 2009, respectively, due primarily to changes in interest rates and other economic conditions experienced during this time. The average maturity of NAICO's fixed maturity investments was 3.7 years and 5.0 years at December 31, 2008 and 2009, respectively.
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, 2009, the total amount of cash and investments restricted as a result of these arrangements was $8.1 million. In addition, NAICO has deposited $28.1 million of cash and investments into a trust account as collateral for a reinsurance agreement in which NAICO is the assuming reinsurer. During 2009, NAICO established a letter of credit in the amount of $500,000 and pledged cash and investments in this amount. The letter of credit secures reserves assumed under a quota share reinsurance agreement.