The Company 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.
The impact of a recession on the Company 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 the Company. A recession might also cause defaults on fixed-income securities owned by NAICO or Chandler Barbados. 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.
The Company's insurance subsidiaries are subject to regulation by government agencies in the jurisdictions in which they do business. The nature and extent of such regulations vary from jurisdiction to jurisdiction, but typically involve prior approval of the acquisition of control of an insurance company or of any company controlling an insurance company, regulation of certain transactions entered into by an insurance company with any of its affiliates, approval of premium rates, forms and policies used for many lines of insurance, standards of solvency and minimum amounts of capital and surplus which must be maintained, establishment of reserves required to be maintained for unearned premiums, unpaid losses and loss adjustment expenses or for other purposes, limitations on types and amounts of investments, restrictions on the size of risks which may be insured by a single company, licensing of insurers and agents, deposits of securities for the benefit of policyholders and the filing of periodic reports with respect to financial condition and other matters. In addition, regulatory examiners perform periodic examinations of insurance companies. Such regulation is generally intended for the protection of policyholders rather than shareholders or creditors.
In addition to the regulatory oversight of the Company's insurance subsidiaries, the Company is also subject to regulation under the laws of the Cayman Islands and the Oklahoma Insurance Code. The Oklahoma Insurance Code contains certain reporting requirements including those requiring the Company, as the ultimate parent company, to file information relating to its capital structure, ownership and financial condition and general business operations of its insurance subsidiaries. The Oklahoma Insurance Code contains special reporting and prior approval requirements with respect to transactions among affiliates. The Oklahoma Insurance Code also imposes certain requirements upon any person controlling or seeking to control an insurance company domiciled in Oklahoma. Control is generally presumed to exist if any person, directly or indirectly, owns, controls, holds with the power to vote or holds proxies representing 10% or more of the voting securities of the insurance company or of any other person or entity controlling the insurance company. The 10% presumption is not conclusive and control may be found to exist at less than 10%. Persons owning any securities of the Company must comply with the Oklahoma Insurance Code. See "BUSINESS - Regulation."
The following tables set forth premiums earned on a gross basis (before reductions for premiums ceded to reinsurers) and on a net basis (after such reductions) for each insurance program as well as each line of insurance as of December 31 for each year presented:
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 25% in 1998, increased 72% in 1999 and increased 25% 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 quota share reinsurance which reduced net premiums earned in 2000 by $4.2 million in this program.
Gross premiums earned in the group accident and health program increased 81% and 50% in 1998 and 1999, respectively, and decreased 63% in 2000. Net premiums earned increased 102% and 78% in 1998 and 1999, respectively, and decreased 61% in 2000. NAICO has discontinued this program.
The following table sets forth the Company's policy acquisition costs for each of the three years ended December 31, 1998, 1999 and 2000:
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 $5.0 million for the purchase of the quota share reinsurance in the fourth quarter of 2000. Net policy acquisition costs decreased $2.2 million in 2000 due to the purchase of the quota share reinsurance, net of the adjustment for deferred acquisition costs.
Certain litigation expenses may be recovered from the Company's directors and officers liability insurer ("D&O Insurer"). As a result of various events in 1995, the Company recorded an $818,000 estimated recovery of costs from the D&O Insurer related to a $1 million claim for reimbursable amounts previously paid that relate to allowable defense and litigation costs for such parties. In 1996, the Company recorded an additional estimated recovery of $982,000. The Company received a payment for the 1995 claim during 1996 in the amount of $795,000. In connection with the Oklahoma Court proceedings, the Company recorded an additional estimated recovery of $2.7 million from the D&O Insurer. The Company is entitled to a total of $5 million under the applicable insurance policy to the extent it has advanced reimbursable expenses. Some amounts have been previously paid without dispute and the Company is negotiating with the D&O Insurer for payment of the policy balance. The Company could recover the remaining policy limits or could compromise its claim, and could incur significant costs in settling this matter.
The provision for or benefit from federal income taxes of the consolidated U.S. subsidiaries varies with the level of income or loss before income taxes of such subsidiaries. The provision or benefit relative to the consolidated income before income taxes will also vary dependent on the income before income taxes reported by the consolidated U.S. subsidiaries.
The Company is a reinsurance company and a holding company receiving cash principally through equity sales, borrowings and subsidiary dividends, subject to various regulatory restrictions described in "Regulation" and the Notes to Consolidated Financial Statements. The capacity of insurance and reinsurance companies to underwrite insurance and reinsurance is based on maintaining liquidity and capital resources sufficient to pay claims and expenses as they become due. The primary sources of liquidity for the Company's subsidiaries are funds generated from insurance and reinsurance premiums, investment income, capital contributions from the Company and proceeds from sales and maturities of portfolio investments. The principal expenditures are payment of losses and loss adjustment expenses, insurance operating expenses and commissions.
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 $1,163,000, $55,000 and $180,000 during 1998, 1999 and 2000, respectively, from the sale of investments. The Company received proceeds of $48.0 million, $4.2 million and $16.2 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 their portfolios, Chandler Barbados and NAICO chose to liquidate certain fixed maturity securities that were available for sale prior to their maturities. The average maturity of the Company's investments was 3.9 years and 4.3 years at December 31, 1999 and 2000, respectively.
Cash flows from financing activities include bank borrowings and repayments, the sale of debentures and purchases of the Company's common stock in accordance with the divestiture of stock owned by the CenTra Group. In February 1998, Chandler USA entered into a five-year loan agreement with a bank having a principal amount of $2.3 million. In March 1998, Chandler USA borrowed an additional $6.2 million under an existing loan agreement with a bank. In July 1999, both bank notes were repaid from the proceeds of the debenture offering.
In April 1998, CIM acquired 69,858 shares of the Company's common stock from an agent for approximately $524,000. These shares had previously been pledged to NAICO to secure certain obligations resulting from insurance balances produced by another agent. In December 1999, these shares were transferred to the Company and canceled.
In December 1999, the Company made payments totaling approximately $15.2 million to acquire 1,989,200 shares of its own stock previously owned by CenTra and certain of its affiliates. In November 2000, the Company paid approximately $6.9 million to acquire 1,142,625 shares of its own stock previously owned by CenTra and certain of its affiliates. The shares have been formally canceled. The acquisitions were made in accordance with a divestiture plan which had been proposed by NAICO and adopted by the Nebraska Court.
The Nebraska Court had previously ordered CenTra to divest all shares of Chandler stock owned or controlled by it or its affiliates. During December 1999, the Company acquired 1,989,200 shares of its stock in exchange for payment of $15,204,758 to the CenTra Group and affiliates. During November 2000, the Company 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, the Company 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 the Company 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. The Company 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, subsidiaries of the Company.
While the Company believes that it is likely that the Company and its affiliates will ultimately prevail as to all material claims asserted in the CenTra litigation, should the CenTra litigation be decided adversely to the Company, such event could have a material adverse effect on the Company.
Through 2000, the Company has not experienced any significant problems or disruptions related to year 2000 problems. The Company is not aware of any significant disruptions experienced by its customers, vendors and service providers that would materially affect their ability to do business with the Company. While it is possible that certain year 2000 problems may exist but have not yet materialized, the Company does not expect any year 2000 problems to be encountered in the future that would have a material adverse effect on the operating results of the Company.