During 2004, much of the focus will be on driving operational efficiencies and expense reductions throughout the organization. The reduction in personnel is expected to result in expense savings in the near future. Management acknowledges that the reengineering activities may cause disruptions to operations and has proactively taken actions to mitigate this risk.
Management of the Corporation believes the significant volatility of realized investment gains and losses limits the usefulness of net income as a measure of current operating performance. Management uses the non-GAAP financial measure of net income before realized gains and losses to further evaluate current operating performance. Net income before realized gains and losses is reconciled to net income in the table below:
The Group's business is geographically concentrated in the Mid-West and Mid- Atlantic regions. The following table shows consolidated net premiums written for the Group's five largest states:
The general liability product line combined ratio decreased 48.7 points in 2003 to 122.6%, compared to 171.3% in 2002. The large decrease is due to a higher than desired 2002 loss ratio, which is attributable to 57.8 points of adverse development in 2002 compared to 8.2 points of adverse development in 2003. The 2001 combined ratio was 120.8%. The accident year combined ratio for 2003 was 114.4% compared to 108.8% and 122.9% in 2002 and 2001, respectively. The increase in the 2003 accident year combined ratio is a result of higher severity for this line of business. The difference between the accident and calendar year results in 2002 is primarily due to increases in residential general contractors and developers related construction defect reserves established for prior accident years due to greater than expected frequency and loss severity. The construction defect issues are being addressed by continuing and expanding previous underwriting actions on certain classes of business that are more prone to construction defect claims.
Cash Flow Net cash generated from operations was $168.7 million compared with cash generated of $148.2 million in 2002 and $70.2 million in 2001. The increase for the year 2003 compared to 2002 is due primarily to a $57.2 million reduction in paid losses and LAE as operating revenues for the two years were roughly equal. This increase in cash was partially offset by an increase in payments to reinsurers for premium cessions, contingent commission bonus payments to agents and the final payments of the replacement carrier fee for New Jersey private passenger auto business. The increase in the reinsurance recoverable asset did not significantly impact cash flow in 2003 since there was a corresponding increase in liabilities for most of the increase in this asset. The reinsurance recoverable asset increased $172.8 million with $141.9 million due to increases in loss reserves for future loss payments expected to be paid by reinsurers along with other components as shown in Footnote 7 on page 70 of this Form 10-K. The increase in reinsurance recoverables is due primarily to the Group writing more commercial umbrella business, most of which the premiums and losses are ceded to reinsurers, resulting in an increase in the reinsurance recoverable asset and a corresponding increase in ceded loss, LAE and unearned premium reserves. The increase in cash generated from operations in 2002 was also due primarily to a reduction in paid losses and paid LAE offset partially by payments of the replacement carrier fee for New Jersey private passenger auto business.
The following table presents the Corporation's obligations to make future payments under contractual obligations:
The actuarial assumptions used by the Company in determining its pension and OPEB retirement benefits may differ materially from actual results due to changing market and economic conditions, higher or lower turnover and retirement rates or longer or shorter life spans of participants. While the Company believes that the assumptions used are appropriate, differences in actual experience or changes in assumptions may materially affect the Company's financial position or results of operations.
On September 6, 2002, A.M. Best Company (A.M. Best) affirmed the Group's financial strength rating of "A-" and assigned a positive outlook. In addition, A.M. Best assigned an initial rating of "bbb" to Ohio Casualty Corporation's convertible notes. On August 22, 2003, A.M. Best revised its debt rating criteria and assigned a "bbb-" to Ohio Casualty Corporation's convertible notes. On December 8, 2003 A.M. Best affirmed the Group's "A-" financial strength rating and the Corporation's "bbb-" senior unsecured debt rating and assigned stable outlooks on the ratings.
The National Association of Insurance Commissioners (NAIC) has developed a "Risk-Based Capital" formula for property and casualty insurers and life insurers. The formula is intended to measure the adequacy of an insurer's capital given the asset and liability structure and product mix of the company. As of December 31, 2003, all insurance companies in the Group exceeded the necessary capital requirements.
For the Personal Lines operating segment, the losses and LAE for prior accident years recorded during 2003 and 2002 were concentrated in the personal automobile product line. In 2001, the development occurred in the homeowners product line.
Tax exempt fixed maturity securities increased, as a percentage of amortized cost, to 2.7% of the fixed maturity portfolio at year-end 2003 versus 1.5% and 1.1% at December 31, 2002 and 2001, respectively. The increase in 2003 and 2002 reflects a decision at the end of 2002 to add to municipal holdings in anticipation of improved underwriting results and to take advantage of unique municipal market opportunities. In 2004, as underwriting profitability improves the Corporation and the Group plan to invest more funds into tax exempt fixed maturity securities.