Year Ended December 31, 2002 2003 2004 Insurance operations Loss &loss adjustment expense ratio 57.1% 60.2% 68.6% Expense ratio 44.2 36.6 34.1 Combined ratio 101.3% 96.8% 102.7%
The Company had an increase in real estate income in 2004 as compared to other years resulting from increased closings of units and higher priced unit closings. The average sales price of condominiums closed in 2004 was $297,000 as compared to $275,000 in 2003 and $274,000 in 2002. Real estate income and sales will be minimal in 2005 as most units are sold and closed and the Company does not expect to engage in any further real estate activities in the future. The earnings and funds generated from Harbour Village are being redeployed into the Company’s insurance operations as the project is completed.
Acquisition expenses are amounts that are paid to agents and brokers for the production of premium for the Company offset in part by the ceding commissions we retain from our reinsurers. For our program business, fees are typically earned through ceding commissions and have the effect of lowering our acquisition expenses. Acquisition expenses also include amounts paid for premium taxes to the states where we do business on an admitted basis. Acquisition expenses were $27 million in 2004, $22 million in 2003, and $15 million in 2002. Acquisition expenses as a function of net earned premiums were 19% in 2004 and were 20% in both 2003 and 2002.
Impact of Inflation Property and casualty insurance premiums are established before the amounts of losses and loss adjustment expenses are known and therefore before the extent by which inflation may affect such expenses is known. Consequently, we attempt, in establishing our premiums, to anticipate the potential impact of inflation. However, for competitive and regulatory reasons, we may be limited in raising premiums consistent with anticipated inflation, in which event we, rather than our insureds, would absorb inflation costs. Inflation also affects the rate of investment return on our investment portfolio with a corresponding effect on our investment income. Combined Ratio The combined ratio of an insurance company measures only the underwriting results of insurance operations and not the profitability of the overall company. Our reported combined ratio for our insurance operations may not provide an accurate indication of our overall profitability. For instance, depending on our mix of business, the combined ratio may fluctuate from time to time and may not reflect the overall profitability of our insurance operations. Variable Interest Entities In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46). This interpretation requires the consolidation of entities in which an enterprise absorbs a majority of the entity's expected losses, receives a majority of the expected residual gains, or both, as a result of ownership, contractual or other financial interests in the entity. In December 2003, the FASB issued a revised version of FIN 46, FIN 46(R), which finalized the accounting guidance for VIE. As a result of adopting FIN 46(R), the Company consolidated its non-subsidiary affiliate American Safety RRG. Off-Balance Sheet Arrangements The Company has guaranteed a $2 million letter of credit to the State of Vermont on behalf of American Safety RRG, its non-subsidiary affiliate, since 1988. Forward Looking Statements This Report contains forward-looking statements within the meaning of United States' securities laws that are intended to be covered by the safe harbors created thereby. Such statements reflect the Company's current views with respect to future events and financial performance, including insurance market conditions, future insurance claims and losses, and completion and profitability of the Harbour Village real estate project, as presented in the Company's consolidated financial statements and Exhibit 99 to this Report. In addition, all statements, other than statements of historical facts, included or incorporated by reference in this Report that address activities, events or developments that the Company expects or anticipates will or may occur in the future constitute forward-looking statements.