The ratio of investment income, net of expenses divided by average cash and investments.
Fixed income investments represent 97.5% of invested assets. As of December 31, 2009, the fixed income portfolio consists of 99% investment grade securities, with 1% non-investment grade rated securities, which includes three corporate securities held with a combined market value of $1.3 million, three asset-backed securities held with a combined market value of $0.6 million, one mortgage-backed security with a market value of $0.1 million, and one small tax-exempt municipal bond. The fixed income portfolio has an average rating of Aa3/AA and an average tax equivalent book yield of 5.14%.
Net investment income increased $0.9 million or 6.8% to $13.9 million in 2008 as compared to $13.1 million in 2007. This increase was driven by an increase in average cash and invested assets. Net investment income for 2007 included $720,000 of interest income as a result of the non-recurring impact of the retaliatory tax refund. Average cash and invested assets totaled $367 million for 2008 as compared to $333 million for 2007, representing an increase of $34 million, driven by operating cash flow.
Effective January 1, 2008, the Group increased its reinsurance retention to $850,000 (from a maximum retention of $750,000 in 2007) on the casualty, property and workers’ compensation lines of business. Pollution coverage written by FPIC is now fully retained with a standard sub-limit of $150,000 (and up to $300,000 on an exception basis). Prior to 2008, FPIC reinsured 100% of its pollution coverage, which in the twelve months ended December 31, 2007 represented $1.8 million of ceded written premium. We also purchased an additional $1.0 million of surety coverage (subject to a 10% retention), which resulted in an increased reinsurance coverage to $4.5 million from $3.5 million per principal and a maximum retention of $900,000 per principal as compared to the previous $800,000. The net effect of these changes in reinsurance arrangements increased net premiums written for 2008.
In June 2009, the FASB issued guidance that establishes the FASB Accounting Standards Codification as the source of authoritative GAAP for nongovernmental entities. The Codification will supersede all existing non-SEC accounting and reporting standards. The Codification is effective for financial statements issued for interim and annual periods ending after September 15, 2009. As the Codification will not change existing GAAP, the guidance will not have an impact on our financial condition or results of operations but will change the way the Company refers to GAAP accounting standards.
During the second half of 2008, there were significant disruptions to the financial and equity markets. This resulted from, in part, failures of financial institutions on an unprecedented scale, and caused a significant reduction in liquidity and trading flows in the credit markets in addition to a dramatic widening in credit spreads. Such impacts affected the valuations of both the fixed income and equity securities held by the Group, and resulted in pre-tax charge to earnings of $6.2 million for write-downs of other-than-temporarily impaired securities. Of the $6.2 million in 2008 impairments $3.9 million related to 11 fixed-income securities, and $2.3 million related to 33 equity securities. The fixed income security impairments related to one residential mortgage-backed security ($0.5 million) which experienced increased delinquency and default rates, four asset-backed securities ($0.8 million) whose underlying collateral deteriorated, and six corporate bonds ($2.6 million) whose issuers were a experiencing deteriorating financial condition. The equity security impairments related to twenty-nine common stock securities and four preferred stock securities, which demonstrated weakening fundamentals in their businesses.
The following table presents the (increase) decrease in the liability for unpaid losses and loss adjustment expenses attributable to insured events of prior years incurred in the year ended December 31, 2009 by line of business:
The favorable development on the commercial automobile line of business reflects a reduction in claims frequency for the recent accident years and a lower than expected emergence of losses, particularly on the Group’s heavy truck programs like Ready Mix and Aggregate Haulers. Additionally, in 2009, the favorable development on the 2007 accident year was impacted by better than expected case reserve development.
With $8.3 million, $7.6 million, and $7.6 million of recorded reserves, net of reinsurance, at December 31, 2009, 2008, and 2007, respectively, workers compensation represents 4%, 3%, and 4%, respectively, of the Group’s total carried net loss and loss adjustment expense reserves at December 31, 2009, 2008 and 2007. A portion of this business is assumed from the National Involuntary Pool managed by the National Council on Compensation Insurance (NCCI).
The denominator for diluted earnings per share does not include the effect of outstanding stock options that have an anti-dilutive effect. For the years ended December 31, 2009, 2008 and 2007, 40,000, 115,000 and 40,000 stock options, respectively, were considered to be anti-dilutive and were excluded from the earnings per share calculation.
The Group produces a large percentage of its business through one insurance agent, Davis Insurance Agency (Davis), the owner of which is also a Board member of the Group. In 2009, 2008 and 2007, premiums written through Davis totaled 4%, 4% and 4%, respectively, of the Group’s direct written premiums. Commissions paid to Davis were $1,203, $1,115 and $1,177 in 2009, 2008 and 2007, respectively.