(1)Net premiums written are premiums for all policies sold during a specific accounting period less premiums returned. (2)Statutory loss ratio measures net losses incurred as a percentage of net premiums earned. (3)Statutory loss adjustment expense ratio measures loss adjustment expenses as a percentage of net premiums earned. (4)Statutory underwriting expense ratio measures underwriting expenses as a percentage of net premiums written. (5)Statutory combined ratio measures the percentage of premium dollars used to pay insurance losses, loss adjustment expenses and underwriting expenses. (6)Statutory policyholders' surplus is equal to an insurance company's admitted assets minus liabilities.
likely to occur in the future and could be significant based on uncertainties such as which agents will experience events such as changes in revenue production or profitability. The total 2002 expense of $79.7 million before tax compares to $22.3 million before tax in 2001 and $57.7 million before tax in 2000.
During 2001, loss and loss adjustment expense reserves were strengthened by $29.6 million before tax for the workers' compensation product line and $17.6 million before tax for asbestos related claims development in other product lines. Also in 2001, the Corporation adopted an early retirement plan. Of the approximately 330 employees eligible to retire under the program, 147 accepted. The early retirement plan resulted in a one-time after-tax charge of $4.0 million for the year.
In the first quarter of 2000, the Group made the decision to discontinue its relationship with all Managing General Agents. The business written by the Managing General Agents was acquired in the 1998 purchase of the GAI commercial lines division. The result of the decision was a before-tax write-down of $42.2 million to the agent relationships intangible asset. The asset was also written down in 2000 by $3.8 million before tax as a result of additional agent cancellations for a total write-down of $46.0 million before tax for the year. In 2001, the Corporation further wrote down the agent relationships intangible asset by $11.0 million before tax as a result of additional agency cancellations and for certain agents determined to be impaired.
Consolidated after-tax realized investment gains amounted to $29.4 million in 2002, $135.0 million in 2001 and realized investment losses were $1.5 million in 2000. Throughout 2002 and 2001 the Corporation and the Group sold equities, many of which had substantially appreciated in earlier periods. This sale program was part of an investment management decision to reduce equity holdings in favor of investment grade bonds. The 2001 realized gains included a non-recurring tax benefit of $16.1 million related to the sale of a minority interest in stock of OCNJ.
The largest assets of the Corporation and the Group are their invested assets. Consequently, accounting policies related to investments are critical. See further discussion of important investment accounting policies in the "Critical Accounting Policies" section and in Note 1C. The Corporation and the Group continually evaluate all of their investments based on current economic conditions, credit loss experience and other developments. The Corporation and the Group evaluate the difference between the cost and estimated fair value of their investments to determine whether a decline in value is temporary or other than temporary in nature. This determination involves a degree of uncertainty. If a decline in the fair value of a security is determined to be temporary, the decline is recorded as an unrealized loss in shareholders' equity. If there is a decline in a security's fair value that is considered to be other than temporary, the security is written down to the estimated fair value with a corresponding realized loss recognized in the statement of consolidated income.
The assessment of whether a decline in fair value is considered temporary or other than temporary includes management's judgement as to the financial position and future prospects of the entity issuing the security. It is not possible to accurately predict when it may be determined that a specific security will become impaired. Future impairment charges could be material to the results of operations of the Corporation and the Group. The amount of impairment charge before tax was $10.9 million in 2002, compared to $12.0 million and $16.7 million in 2001 and 2000, respectively. The impairment charge in 2002 represents .3% of the market value at December 31, 2002 of the investment portfolio, compared to .3% in 2001 and ..5% in 2000.
The following table summarizes the total gross unrealized losses, excluding gross unrealized gains, by investment category as of December 31:
As part of the evaluation of the entire $42.9 million aggregate unrealized loss on the investment portfolio, management performed a more intensive review of securities with a relatively higher degree of unrealized loss. In the review for permanently impaired securities as of December 31, 2002, management concluded that of this group of securities with a relatively higher degree of difference between cost and estimated fair value, sixteen securities, with an aggregate unrealized loss of $15.2 million, were suffering only temporary declines in fair value. Of this unrealized loss amount, $3.8 million represented unrealized losses in the securities of Delta Air Lines, Inc. and $5.2 million represented unrealized losses in investment in AMR Corporation. All securities are monitored by portfolio managers who consider many factors such as a company's degree of financial flexibility, management competence and industry fundamentals in evaluating whether the decline in fair value is temporary. Should management subsequently conclude the decline in fair value is other than temporary, the book value of the security is written down to fair value with the realized loss recognized in the statement of consolidated income.
The following table summarizes, for all securities in an unrealized loss position, the gross unrealized loss by length of time the securities have continuously been in an unrealized loss position at December 31, 2002:
Of the securities in an unrealized loss position as of December 31, 2002, the only material concentration by industry segment was in the airline industry. The amount of this concentration as of December 31, 2002 was $9.5 million.
unlimited as in the past, terrorism coverage in the 2002 contracts was modified to exclude or limit coverage for certain upper layers of reinsurance. The Group believes that the terrorism coverage in its reinsurance programs is adequate to protect its financial health. The pricing of our 2002 reinsurance program increased only moderately from prior years. The Group has renewed its reinsurance programs for 2003 except for the bond reinsurance treaty that is expected to be renewed at the April 1, 2003 expiration date. The 2003 program experienced moderate increases in pricing and no significant changes in structure or coverages.
Management analyzes statutory results through the use of insurance industry financial measures including statutory loss and loss adjustment expense ratios, statutory underwriting expense ratio, statutory combined ratio, net premiums written and net premiums earned. The statutory combined ratio is the sum of the statutory loss ratio, the statutory loss adjustment expense ratio, and the statutory underwriting expense ratio. The statutory combined ratio is a commonly used gauge of underwriting performance measuring the percentages of premium dollars used to pay insurance losses and related expenses. All references to combined ratio or its components in the MD&A are calculated on a statutory accounting basis and are calculated on a calendar year basis unless specified on an accident year basis. The combined ratios and component ratios presented for the year ended December 31, 2002 exclude a $7.3 million before-tax charge for the statutory additional minimum pension liability related to the underfunded status of the retirement plan. A discussion of the differences between statutory accounting and accounting principles generally accepted in the United States is included in Note 16.
The All Lines combined ratio increased .2 points to 112.8% in 2002, compared with 112.6% in 2001 and 119.2% in 2000. The 2001 combined ratio of 112.6% excludes the New Jersey transfer fee of $40.6 million, or 2.7 point impact. Further excluding New Jersey private passenger auto results in total, the combined ratio improved 1.8 points in 2002 to 110.3%, compared to 112.1% in 2001. The improvement in the combined ratio in 2002 over 2001 when excluding the $40.6 million New Jersey transfer fee and New Jersey private passenger auto business was due primarily to improvement in the Personal Lines loss ratio. The 2002 Personal Lines loss ratio improved to 64.9% from 71.2% in 2001 excluding the New Jersey transfer fee and New Jersey private passenger auto business.
The loss and loss adjustment expense (LAE) ratios, which measure losses and LAE as a percentage of net earned premiums, were impacted negatively in 2002 by adjustments to estimated losses related to prior years' business. The loss and LAE ratio component of the accident year combined ratio measures losses and LAE arising from insured events that occurred in the respective accident year. The current accident year excludes losses and LAE for insured events that occurred in prior accident years. In total, this increase in provisions for prior accident years' losses and LAE recognized during the year 2002 was $84.4 million before tax.
The total provision for prior years' losses and LAE of $84.4 million recognized during the year 2002 represents 4.3% of loss and loss adjustment expense reserves as of year-end 2001. The comparable amount of provision for prior years' losses and LAE recognized during the year 2001 was $58.5 million before tax representing 3.1% of loss and loss adjustment expense reserves as of year-end 2000. This was concentrated in the workers' compensation product line and the general liability product line of the Commercial Lines operating segment. The comparable amount for provisions for prior years' losses and loss adjustment expenses recognized during the year 2000 was $56.8 million before tax. This represents 3.1% of loss and loss adjustment expense reserves as of year-end 1999. This was concentrated primarily in the workers' compensation and general liability product lines.
Catastrophe losses in 2002 totaled $20.8 million, compared with $34.6 million in 2001 and $36.2 million in 2000. The Group was impacted by 25 separate catastrophes in 2002, compared with 19 catastrophes in 2001 and 24 in 2000. Catastrophe losses added 1.4 points to the combined ratio in 2002, compared with 2.3 points in 2001 and 2.4 points in 2000. The effects of catastrophes on the Corporation's results cannot be accurately predicted. As such, severe weather patterns, acts of war or terrorist activities could have a material adverse impact on the Corporation's results, reinsurance pricing and availability of reinsurance.
The underwriting expense ratio, which measures underwriting expenses as a percentage of net premiums written, decreased by .5 points in 2002 to 34.9%, compared with 35.4% in 2001 and 34.8% in 2000. The 2001 underwriting expense ratio includes 2.7 points from the $40.6 million charge for the New Jersey transfer fee. The underwriting expense ratio for the year 2002 increased compared to the year 2001, after excluding the 2.7 point impact of the New Jersey transfer fee, in part due to two factors with a total impact of approximately 1.6 points. These two factors were the non-renewal of the New Jersey private passenger auto business, which had lower commission rates and lower variable processing costs than most other business, and the elimination of ceding commissions received in previous years on umbrella premiums ceded to reinsurers. The 2002 commission expense ratio, a component of the underwriting expense ratio, was 17.8% or 1.2 points higher than expected due to higher than expected umbrella net premiums written, which has a relatively high commission rate on a net of reinsurance basis, and more importantly, due to higher than expected accruals for agent bonus commissions, as certain agents were more profitable than expected. This higher commission expense reflected the improved loss ratio for 2002, which at 62.2% for the year 2002 was a 4.3 point improvement over the year 2001 of 66.5%. Excluding the New Jersey transfer fee, the 2.1 point improvement in the 2001 underwriting expense ratio compared with the ratio in 2000 was the result of actions to lower commissions, eliminate workers' compensation policyholder dividends and decrease the employee count. The actions to lower commissions to current market levels for selected product lines improved the 2001 underwriting expense ratio .5 points. The actions to eliminate workers' compensation policyholders dividends on new and renewal business and changes in reserves for dividends of issued policies improved the 2001 underwriting ratio .7 points. Reductions in employee count continued to improve results in 2002. The employee count was 3,004 as of December 31, 2002, compared with 3,365 at December 31, 2001 and 3,470 at December 31, 2000.
In June of 2001, the Corporation introduced an organizational structure around three business units: Commercial Lines, Specialty Lines, and Personal Lines. These business units represent the Corporation's operating segments as well as its reportable segments. Within each operating segment are distinct insurance product lines that generate revenues by selling a variety of personal, commercial, and surety insurance products. The Commercial Lines operating segment sells commercial multiple peril, commercial auto, general liability, and workers' compensation insurance as its primary products. The Specialty Lines operating segment sells commercial umbrella and bond insurance as its primary products. The Personal Lines operating segment sells personal automobile and homeowners insurance as its primary products. The Corporation also has an all other segment, which derives its revenue from investment income and premium financing.
(a) All combined ratios and all component ratios presented for the year 2002 exclude $7.3 million before-tax charge for statutory additional minimum pension liability. (b) Personal Automobile includes both Auto-Agency and Auto-Direct. (c) Accident Year 2001 and Calendar Year 2001 exclude 9.0 point impact of New Jersey renewal obligation transfer fee. Including the transfer fee, the Automobile-Personal Accident Year 2001 and Calendar Year 2001 statutory combined ratios would have been 117.0% and 118.9%, respectively. (d) Accident Year 2001 and Calendar Year 2001 exclude 2.7 point impact of New Jersey renewal obligation transfer fee. Including the transfer fee, the All Lines Accident Year 2001 and Calendar Year 2001 statutory combined ratios would have been 110.4% and 115.3%, respectively. (e) Accident Year 2001 and Calendar Year 2001 exclude 6.3 point impact of New Jersey renewal obligation transfer fee. Including the transfer fee, the Personal Lines Accident Year 2001 and Calendar Year 2001 combined ratios would have been 116.7% and 119.2%, respectively. (f) The measurement date for Accident Year data is December 31, 2002.
The Group continued to achieve average renewal price increases for workers' compensation of 20.1% for 2002, compared with increases of 16.6% and 12.4% for 2001 and 2000, respectively. Net premiums written for 2002, 2001 and 2000 totaled $143.9 million, $148.6 million and $185.8 million, respectively.
Due to continued underwriting and pricing actions, workers' compensation loss ratios should continue to show improvement. In 2002, the loss ratio decreased 15.2 points from 2001. Accident year claim count for 2002 decreased 18.0% from 2001. New and renewal pricing remains strong for this line of business.
Net premiums written for the commercial multiple peril, fire and inland marine product lines increased 16.4% to $320.4 million in 2002, compared with $275.2 million in 2001 and $276.5 million in 2000. The combined ratio decreased to 95.8% in 2002 from 106.4% in 2001 and 111.1% in 2000. The improvement resulted from strong new and renewal pricing and more selective and focused underwriting.
Net premiums written for the monoline general liability product line increased $5.4 million, or 6.9% in 2002 to $84.5 million, compared with $79.0 million in 2001 and $80.7 million in 2000. The increase is due to higher new and renewal pricing levels. The 2001 decrease reflected the Group's focus on fundamental underwriting strategies.
Specialty Lines combined ratio for the year 2002 was higher, but still profitable, at 94.0%, compared with 90.8% and 79.8% for 2001 and 2000, respectively.
The Personal Lines combined ratio for the year 2002 decreased 5.1 points to 114.1% in 2002, compared with 119.2% in 2001 and 113.5% in 2000. Excluding the 1.5 point impact in 2002 on Personal Lines from the reallocation of loss adjustment expense reserve estimates described in the "All Lines Discussion," and excluding the 6.3 point impact of the New Jersey transfer fee in 2001, the Personal Lines combined ratio would have been 112.6% for 2002 and 112.9% for 2001. This small improvement for 2002 is attributable to the implementation of price increases, insurance scoring, enhanced claims management procedures, withdrawal from states that have proven unprofitable to the Group's operations, and lower than average losses from catastrophes. The Group continued to narrow its geographic focus in Personal Lines during 2002. The Group recently received all necessary approvals from regulators to withdraw its Personal Lines business from Florida, Georgia and Texas. The 2002 net premiums written in Florida, Georgia and Texas were approximately $15.0 million. The Group does not write Personal Lines business in California.
Given the unfavorable regulatory environment for private passenger auto in New Jersey and uncertainty over the future profitability of the Group's private passenger auto business in the state, the Group announced in the fourth quarter of 2001 the transaction to allow the Group in early 2002 to stop writing private passenger auto business in New Jersey. The transaction, described in the "Operating Results" section, has effectively exited the Group from New Jersey personal lines auto business in 2002 and future years. New Jersey's private passenger auto net premiums written represented approximately 7.5% of the Group's total private passenger auto book of business in 2002, compared to 27.0% in 2001 and 20.8% in 2000. New Jersey regulation mandates private passenger automobile insurers in the state to provide insurance to all eligible consumers with limited exceptions. This "take-all-comers" regulation eliminated the Group's ability to control the volume and selection of writings in the state. Poor underwriting results in New Jersey was the primary cause of the poor performance in 2002 and 2001. The New Jersey private passenger auto results added 6.2 and 7.1 points to the 2002 and 2001 Personal Lines loss ratio, respectively. Since 1999, New Jersey has required insurance companies to write a portion of their personal auto premiums in Urban Enterprise Zones (UEZ). These zones are generally higher risk urban areas. Companies are also assigned premiums if they do not write the required quota. In 2002, the Group wrote $3.7 million in UEZ and assigned premiums, compared with $12.4 million in UEZ and assigned premiums in 2001. In 2000, the Group wrote $11.4 million in UEZ and assigned premiums. Excluding the discontinued New Jersey business and the impact of the reallocation of loss adjustment expense reserves, the Personal Lines combined ratio improved 5.6 points to 106.2% in 2002, compared to 111.8% in 2001. The Group is implementing price increases, coverage restrictions and claims management procedures to improve results.
Although the Group discontinued the private passenger auto - direct product line, the Group remains committed to expanding its Internet capabilities that focus on full service options for our agents and convenience options for our policyholders.
Homeowners product line net premiums written fell 5.1% in 2002 to $153.7 million from $162.0 million in 2001 and $173.2 million in 2000. The Group has placed emphasis on price increases, insurance scoring and agency management. Average implemented rate increases were 10.1%, 2.8%, and 6.6% in 2002, 2001 and 2000, respectively. The Group introduced an Insurance- To-Value program in 2000, which addressed underinsured homeowner properties and emphasized adequate replacement cost values.
Management of the Corporation has identified the policies listed below as significant accounting policies that are critical to the Corporation's business operations and influence the consolidated results of operations and financial performance. The policies listed below were selected as they require a higher degree of complexity or use subjective judgements or assessments. These policies follow accounting principles generally accepted in the United States. A brief summary of each critical accounting policy follows. For a complete discussion on the application of these and other accounting policies, see Note 1, "Summary of Significant Accounting Policies."
The Group establishes reserves for losses and loss adjustment expenses equal to the estimated amount to settle both reported (case reserves) and unreported claims (Incurred But Not yet Reported). For reported losses, a case reserve is established within the parameters of coverage provided in the insurance policy. For IBNR losses, reserves are estimated using established actuarial methods. An estimate of the loss and loss adjustment expense for each claim is developed using the facts in each case, the Group's experience with similar cases, the effects of current developments and anticipated trends. The methods and assumptions of making such estimates are continually reviewed and updated when considered appropriate. Any resulting adjustments are reflected in the consolidated statements of income for the period in which such estimates are changed. Reserves established in prior years are adjusted as loss experience develops and new information becomes available. Adjustments to previously estimated reserves, both positive and negative, are reflected in the consolidated statements in the periods in which they are made and are referred to as prior period development. Because of the high degree of uncertainty involved in estimating loss and loss adjustment expense reserves, revisions to estimated reserves could have a material impact on the results of operations of the Group.
The Group establishes a deferred asset for costs that vary with and are primarily related to acquiring property or casualty business. The acquisition costs deferred consist of commissions, brokerage fees, salaries and benefits and other underwriting expenses to include allocations for inspections, taxes, rent and other expenses that vary directly with the acquisition of insurance contracts. These costs are amortized over the life of the underlying policies. Periodically, an analysis of the asset is performed in relation to the expected recognition of revenues including investment income to determine if any deficiency exists. No deficiencies have been indicated for the periods presented.
The Corporation and the Group have recorded an asset, which it refers to as agent relationships, for the excess of cost over the fair value of net assets acquired in connection with the 1998 GAI commercial lines acquisition. The Corporation and the Group followed the practice of allocating purchase price to specifically identifiable intangible assets based on their estimated values as determined by appropriate valuation models. The agent relationships asset is amortized on a straight-line basis over an estimated useful life of twenty-five years. The estimated useful life was based on the Group's actual experience for agency appointment terms for similar agents, which averaged approximately twenty- five years in length. The asset is evaluated periodically as events
or circumstances, such as cancellation of agents, indicate a possible inability to recover their carrying amount. Cancellation of certain agents for reasons such as lack of revenue production or poor quality of business produced does not necessarily change the estimated useful life of remaining agents representing the agent relationships intangible asset. Such evaluation is based on various analyses, including cash flow and profitability projections that incorporate, as applicable, the impact on existing company businesses. The analyses necessarily involves significant management judgments to evaluate the capacity of an acquired business to perform within projections. If future undiscounted cash flows are insufficient to recover the carrying amount of the asset, an impairment loss is recognized in income in the period in which the future cash flows are identified to be insufficient in comparison to the carrying amount of the asset. The Corporation and the Group anticipate that based on future events or circumstances additional write-downs for impairment will be made in future periods.
In accordance with SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" the Group capitalizes costs incurred during the application development stage for the development of internal-use software. These costs primarily relate to payroll and payroll-related costs for employees along with costs incurred for external consultants who are directly associated with the internal-use software project. Costs such as maintenance, training, data conversion, overhead and general and administrative are expensed as incurred. Management believes the expected future cash flows of the asset exceed the carrying value. The expected future cash flows are determined using various assumptions and estimates. Changes in these assumptions could result in an immediate impairment to the asset and a corresponding charge to net income. The costs associated with the software are amortized on a straight-line basis over the estimated useful life of ten years commencing when the software is substantially complete and ready for its intended use.
Net cash generated from operations was $148.2 million in 2002, compared with cash generated of $70.2 million in 2001 and $99.6 million in 2000. The increase in 2002 over 2001 was due primarily to a reduction in paid losses and loss adjustment expenses. The increase in cash generated from operations in 2001 was also due primarily to a reduction in paid losses and paid loss adjustment expenses. Investing activities used net cash of $173.7 million in 2002, compared with net cash used of $57.4 million in 2001 and $103.5 million in 2000. Total cash used for financing activities was $4.6 million, $10.6 million and $56.0 million in 2002, 2001 and 2000, respectively. Cash used for financing decreased year over year due to gross proceeds of $201.3 million received from the convertible debt offering that occurred in the first quarter of 2002 which was partially offset by repayment of the previous bank debt. During 2001, the decrease from prior year was a result of the elimination of shareholder dividends. Overall, total cash used in 2002 was $30.0 million, compared with cash generated of $2.2 million in 2001 and cash used of $59.9 million in 2000.
Statutory surplus, a traditional insurance industry measure of strength and underwriting capacity, was $725.7 million at December 31, 2002, compared with $767.5 million at December 31, 2001 and $812.1 million at December 31, 2000. Statutory surplus decreased 5.4% from 2001 resulting from the decline in the market value of its equity investment portfolio offset by statutory income and other surplus changes. On January 1, 2001, statutory surplus was reduced by $21.7 million to $790.4 million for the cumulative effect of adopting new required statutory accounting principles. The 2001 surplus was further reduced by the $26.8 million after-tax charge associated with the New Jersey private passenger auto transfer and a decrease in the market value of the equity investment portfolio. Statutory surplus increased in 2001 due to the sale of a minority interest in the stock of a subsidiary, which caused a non-recurring tax benefit of $16.1 million.
The ratio of premiums written to statutory surplus is one of the measures used by insurance regulators to gauge the financial strength of an insurance company and indicates the ability of the Group to grow by writing additional business. At December 31, 2002, the Group's premiums written to surplus ratio is 2.0 to 1, compared to 1.9 to 1 in 2001 and 2000.
fund and reinsured losses are paid to the Group under the terms of the reinsurance agreement with various reinsurers. The reinsurers bear the risk of losses in excess of the fund. The Group's ability to manage the investments of the fund reduces credit risk related to reinsurers. The balance of the fund as of December 31, 2002 was approximately $129.0 million.
GAI agreed to maintain reinsurance on the commercial lines business that the Group acquired from GAI and its affiliates in 1998 for loss dates prior to December 1, 1998. GAI is obligated to reimburse the Group if GAI's reinsurers are unable to pay claims with respect to the acquired commercial lines business.
The Group's largest liabilities are reserves for losses and loss adjustment expenses. The accounting policies related to the loss and loss adjustment expense reserves are considered critical. Loss and loss adjustment expense reserves are established for all incurred claims and are carried on an undiscounted basis before any credits for reinsurance recoverable. Actual losses and loss adjustment expenses may change with further developments. These reserves amounted to $2.4 billion at December 31, 2002, $2.1 billion at December 31, 2001 and $2.0 billion at December 31, 2000. As of December 31, 2002, the reserves by operating segment were as follows: $1.5 billion Commercial Lines, $.4 billion Specialty Lines and $.5 billion Personal Lines.
The Group's actuaries conduct a reserve study using generally accepted actuarial methods each quarter from which point estimates of ultimate losses and loss adjustment expenses by product line or coverage within product line are selected. In selecting the point estimates, thousands of data points are reviewed and the judgment of the actuaries is applied broadly. Each quarter
There are several key assumptions supporting the point estimate including those summarized below. The fundamental assumption is that actuarial reserving methods, using historical loss experience organized by line of business, or coverage within line, and accident year at successive evaluation points, applied by experienced reserving actuaries, produces reasonable estimates of future loss development on prior insured events. Supporting assumptions internal to company operations are as follows: recording of premium and loss statistics in the appropriate detail has been accurate and consistent; claims handling, including the recording of claims, payment and closure rates, and case reserving has been consistent; the quality of business written and the mix of business (e.g. states, limits, coverages, and deductibles) have been consistent; rate changes and changes in policy provisions have been measured accurately; reinsurance coverage has been consistent and reinsured losses are collectible. To the extent any of the above factors have changed over time, attempts must be made to quantify and adjust for the changes. Supporting assumptions related to the external environment are as follows: tort law and the legal environment have been consistent; coverage interpretation by the courts has been consistent; regulations regarding coverage provisions have been consistent; loss inflation has been relatively steady. To the extent any of the above factors have changed over time, attempts must be made to quantify and adjust for the changes. The more the inconsistency, the greater the uncertainty of the loss reserve estimates.
In recent years, asbestos and environmental liability claims have expanded greatly in the insurance industry. Historically, the Group has written small commercial accounts and has not sold policies with significant manufacturing liability coverages. Within the manufacturing category, the Group has concentrated on the light manufacturers, which further limits exposure to environmental claims. Consequently, the Group believes it does not have exposure to the primary defendants involved in major asbestos litigation. The Group's exposure to asbestos is related to installers and distributors as opposed to the large manufacturers. In 2001, the Group increased reserves because of the expansion of litigation to these types of business. A significant part of the Group's exposure to environmental liability is related to underground storage tanks. The Group has limited exposures to the national priority list. In 2002 the Group re-classified approximately $5.0 million of homeowners reserves related to underground storage tanks as environmental reserves. Due to the relatively small exposure to asbestos and environmental liability and the unique nature of this exposure, the Group does not rely on claim count data in determining reserves. For 2002, 2001 and 2000, respectively, the asbestos and environmental reserves, net of reinsurance, were $54.1 million, $49.1 million and $40.4 million. Asbestos reserves were $27.9 million, $29.4 million and $13.5 million and environmental reserves were $26.2 million, $19.7 million and $26.9 million for those respective years.
The number of construction defect claims reported in 2002, 2001 and 2000, respectively, were 213, 169 and 118. The paid losses, net of reinsurance, in 2002 were $10.1 million, compared to $6.3 million in 2001 and $1.8 million in 2000. The paid allocated loss adjustment expenses, net of reinsurance, for construction defect claims were $4.6 million in 2002, compared with $2.1 million in 2001 and $2.0 million in 2000. These totals exclude construction defect losses from the state of California. Although the Group has construction defect losses from California exposure, it excludes California from this data because the Group stopped writing in the state in 1993 and the remaining claims are minimal and of a different nature than our exposure in the rest of the country. This data also includes claims assumed from the GAI acquisition beginning in November 2001, slightly distorting the 2001 numbers.
The Group writes excess capacity liability business with large policy limits that are heavily reinsured. There have been very few losses to date on this business, but the large policy limits increase the uncertainty of future losses before the application of reinsurance. There is a relatively small amount of loss data available for this business. The Group's coverage for approximately three-fourths of this business written during 2002 begins when losses or loss adjustment expenses on an individual claim reaches $10.0 million or more. The Group's limit of coverage on an individual claim for approximately two-thirds of this business written during 2002 is $25.0 million. Reinsurance purchased by the Group limits its retention of losses to $1.0 million. During 2002, the Group wrote approximately 1,700 of these excess capacity liability policies, representing an annual growth of approximately 20% since 2000.
The losses and loss adjustment expenses on prior accident years totaling $84.4 million reflect an update to estimates for reserves based on new information during the year 2002, resulting in recognition during 2002. Each quarter during 2000 through 2002 a thorough loss reserve study was conducted using data and other information updated and available as of the end of each quarter. Based on these studies, liabilities for loss and loss adjustment expenses are established for the estimated ultimate costs of settling claims for insured events, for both reported claims and incurred but not reported claims. As more information becomes available and claims are settled in subsequent periods, the estimated liabilities are adjusted upward or downward.
For each reserve study, several generally accepted actuarial reserving techniques were applied to determine estimates of ultimate loss and loss adjustment expense by product line by accident year. For each accident year and product line, two or more estimates of ultimate loss were determined and a final estimate was selected. Key assumptions were applied consistently during 2000 through 2002.
The reserve study of third quarter 2002 revealed the average severity (loss per claim) and the amount of legal expense for certain types of construction defect claims that were much greater than previously seen or anticipated. The study also indicated that more of these severe claims had been reported and were expected to be reported in the future than previously anticipated, despite a decrease in frequency of other types of general liability claims. It was concluded that these construction defect claims impacted the general liability, commercial multiple peril and commercial umbrella product lines. As a result of this third quarter 2002 review, the estimate of ultimate loss and loss adjustment expense for this exposure was increased. For these three product lines combined, the impact of construction defect in the year 2002 was $62.2 million before tax. The loss estimates for these claims are based on currently available information. However, given the expansion of coverage and liability by the courts and legislatures, there is substantial uncertainty as to the ultimate liability.
The year 2002 also experienced greater than expected loss activity from older accident years for the commercial automobile product line. This was due to greater than expected severity on bodily injury claims. As a result, the estimate of ultimate loss and loss adjustment expense was increased by $17.0 million.
Reserve development in the year 2002 occurred as follows: $(15.8) million for accident year 2001, $10.2 million for accident year 2000, $16.1 million for accident year 1999, and $73.9 million for accident years 1998 and prior. Reserve development in the year 2001 occurred as follows: $31.1 million for accident year 2000, $10.9 million for accident year 1999 and $16.5 million for accident years 1998 and prior. Reserve development in the year 2000 occurred by accident year as follows: $60.0 million for accident year 1999 and ($3.2) for accident years 1998 and prior. The amount of the loss and loss adjustment expense reserves by accident year at the beginning of 2002 was $625.3 million for accident year 2001, $409.6 million for accident year 2000, and $268.6 million for accident year 1999.
At year-end 2002, consolidated investments had a carrying value of $3.5 billion. The excess of market value over cost was $392.2 million, compared with $420.9 million at year-end 2001 and $629.4 million at year-end 2000. The decrease in 2002 and 2001 was largely due to the recognition of realized gains in connection with the sale of appreciated equity securities and declines in the market value of certain equity securities. The reduction in unrealized gains related to equity securities in 2002 was somewhat offset by an increase in unrealized gains in the fixed maturity portfolio of $130.0 million.
The consolidated fixed maturity portfolio of the Corporation and the Group has an intermediate duration and a laddered maturity structure. The Corporation and the Group always remain fully invested and do not time markets. The Corporation and the Group also have no off-balance sheet investments or arrangements as defined by section 401(a) of the Sarbanes- Oxley Act of 2002.
As of December 31, 2002, the Corporation and the Group held $1,154.3 in mortgage-backed securities, compared with $1,107.8 million and $1,124.0 million at December 31, 2001 and 2000, respectively. The majority of mortgage-backed security holdings are in sequential structures, planned amortization class and agency pass-through securities. Of this portfolio, $7.8 million, $10.0 million and $13.1 million were invested in more volatile bond classes (e.g. interest-only securities which do not return principal at maturity, super-floater securities which pay interest at a formula rate that is a function of LIBOR and inverse-floater securities which pay interest per a formula that adjusts inversely to changes in LIBOR rates) in 2002, 2001 and 2000, respectively.
At December 31, 2002, the fixed maturity portfolio included non-investment grade securities and non-rated securities that had a fair value of $105.3 and comprised 3.0% of the investment portfolio. This compares to a fair value of $94.3 million and $127.4 million at December 31, 2001 and 2000, respectively. These securities comprised 2.8% and 3.8% of the investment portfolio at December 31, 2001 and 2000, respectively. Following is a table displaying non-investment grade and non-rated securities in an unrealized loss position at December 31:
At year-end 2002, consolidated equity investments had a market value of $312.5 million. Equity investments have decreased, as a percentage of market value of the consolidated portfolio, from 22.7% at year-end 2000 to 8.9% at year-end 2002. This decrease is primarily attributable to the Corporation's and the Group's 2002 and 2001 actions which reduced assets invested in equities.