Our income is principally derived from insurance premiums received from insureds in the commercial lines (businesses insured) and personal lines (individuals insured) segments, less the costs of underwriting the insurance policies, the costs of settling and paying claims reported on the policies, and from investment income reduced by investment expenses and gains or losses on holdings in our investment portfolio. Variability in our income is caused by a variety of circumstances, some within the control of our companies and some not within their control. Premium volume is affected by, among other things, the availability of quality, properly-priced underwriting risks being produced by our agents, the ability to retain on renewal existing good-performing accounts, competition from other insurance companies, regulatory rate approvals, our reputation, and other limitations created by the marketplace or regulators. Our underwriting costs are affected by, among other things, the amount of commission and profit-sharing we pay our agents to produce the underwriting risks we receive premiums for, the cost of issuing insurance policies and maintaining our customer and agent relationships, marketing costs, taxes we pay to the states we operate in on the amount of premium we collect, and other assessments and charges imposed on our companies by the regulators in the states in which we do business. Our claim and claim settlement costs are affected by, among other things, the quality of our underwriting accounts, severe weather in our operating region, the nature of the claim, the regulatory and legal environment in our territories, inflation in underlying medical and property repair costs, and the availability and cost of reinsurance. Our investment income and realized gains and losses are determined by, among other things, market forces, the rates of interest and dividends paid on our portfolio holdings, the credit or investment quality of the issuer and the success of its underlying business, the market perception of the company invested in, and other factors such as ratings by rating agencies and analysts.
We generally apply the following standards in determining whether the decline in fair value of an investment is other than temporary:
Our growth in premiums and underwriting results have been, and continue to be, influenced by market conditions. Pricing in the property and casualty insurance industry historically has been cyclical. During a soft market cycle, price competition is prevalent and makes it difficult to write and retain properly priced personal and commercial lines business. Our policy is to maintain our disciplined underwriting and pricing standards during soft markets, even at the expense of premium growth. The insurance industry is currently experiencing a hard market cycle during which price competition is less significant than during a soft market cycle. The hard market cycle allowing higher premium rates has been ongoing now for more than three years, and some pricing competition is becoming evident in lines of business which are predominantly property exposures. A sustained hard market typically has a positive effect on premium growth, resulting in a more acceptable profit margin. The cyclicality of the market is difficult to anticipate, and while there is some pricing competitiveness in the market, today’s pricing is generally consistent with a continuing hard market.
Underwriting expenses increased by $4.7 million, or 32.9%, to $18.9 million for the year ended December 31, 2002, from the same period in 2001. This increase was attributable to an increase in expenses due to higher amortization of deferred policy acquisition costs resulting from higher premium volume, ongoing conversion of our information systems and the associated cost of maintaining two data processing systems during the transition period, a full year of Franklin Holding operations and the establishment of underwriting and marketing teams for future production in Pennsylvania. The increase in expenses also reflects our strategy of paying higher profit sharing commissions to our producers for good loss experience.
At December 31, 2003, the Group’s subsidiary FHC has net operating loss carryforwards available to offset future federal taxable income as follows: