OPERATING EXPENSES primarily represent compensation, marketing and other general and administrative expenses. These expenses were $406.0 million in 2000 compared to $360.4 million in 1999 and $328.2 million in 1998. The increase during 2000 compared to 1999 was primarily related to acquisition of Wanger Asset Management, L.P. on September 29, 2000 and the expansion of investment management capabilities, distribution, and electronic commerce activities. The increase in 1999 compared to 1998 was primarily due to the acquisitions of Crabbe Huson and Progress in the second half of 1998 and to increases in compensation and marketing expenses. Operating expenses expressed as a percent of average total assets under management were 0.59% in 2000 and 1999, and 0.60% in 1998.
INTEREST EXPENSE, NET was $22.5 million in 2000 compared to $19.3 million in 1999 and $14.9 million in 1998. Interest expense primarily consists of interest on notes payable and interest on the Liberty Funds Group revolving credit facility which is utilized to finance sales commissions paid in connection with the distribution of mutual fund shares sold with 12b-1 distribution fees and contingent deferred sales charges. Interest expense was net of interest income of $22.9 million, $17.3 million and $8.4 million in 2000, 1999 and 1998, respectively.
INCOME TAX EXPENSE was $61.0 million or 32.3% of pretax income in 2000 compared to $55.1 million or 35.7% of pretax income in 1999 and $54.4 million or 30.4% of pretax income in 1998. The decrease in the effective tax rate in 2000 compared to 1999 primarily reflects a reduction to the valuation allowance established for unrealized capital losses in the "available for sale" investment portfolio and the issuance of a favorable IRS determination with respect to an outstanding audit issue in the fourth quarter of 2000. The significantly lower effective tax rate on pretax income in 1998 was primarily attributable to reductions in the deferred tax asset valuation allowance on federal net operating loss carryforwards.
Based upon the information and assumptions the Company uses in its stress-test scenarios, at December 31, 2000, management estimates that if the S&P 500 Index decreases by 10%, the net fair value of its assets and liabilities described above would decrease by approximately $7.2 million. Based upon the information and assumptions the Company used in its stress-test scenarios at December 31, 1999, management estimated that if the S&P 500 Index decreased by 10%, the net fair value of its assets and liabilities described above would have decreased by approximately $0.2 million. If option implied volatilities were to increase by 100 basis points, management estimates that the net fair value of its assets and liabilities would have decreased by approximately $1.4 million and $5.2 million as of December 31, 2000 and 1999, respectively.
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." In June 1999, the FASB issued SFAS No. 137 "Accounting for Derivative Instruments and Hedging Activities--Deferral of the Effective Date of FASB Statement No. 133." This statement amended SFAS No. 133 to defer its effective date one year to fiscal years beginning after June 15, 2000. In June 2000, the FASB issued SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities"--an amendment of SFAS No. 133. This statement makes certain changes in the hedging provisions of SFAS No. 133 and is effective concurrent with SFAS No. 133 (collectively hereafter referred to as the "Statement"). The Statement will require the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset by the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. Upon adoption in the first quarter of 2001, the Company will be required to record a cumulative effect adjustment to reflect this accounting change.
To the extent that unanticipated surrenders cause Keyport to sell for liquidity purposes a material amount of securities prior to their maturity, such surrenders could have a material adverse effect on the Company. Although no assurances can be given, Keyport believes that liquidity to fund anticipated withdrawals would be available through incoming cash flow and the sale of short-term or floating-rate instruments, thereby precluding the sale of fixed maturity investments in a potentially unfavorable market. In addition, the Company's fixed-rate products incorporate surrender charges to encourage persistency and to make the cost of its policyholder balances more predictable. Approximately 75.4% of the Company's fixed annuity policyholder balances were subject to surrender charges or restrictions as of December 31, 2000.