The Company conducts business from various facilities, most of which are leased. In addition, the Company owns its administrative offices in Overland Park, Kansas, Copenhagen, Denmark and Aachen and Munich, Germany.
Net premiums written in 1996 increased $1.012 billion, of which $1.308 billion reflects recording a full year of the operating results for the 1995 acquisitions of Frankona Re and the Aachen Re Business (the "Acquired Businesses") in 1996 compared to recording only five months of operating results in 1995. This 1996 increase in net premiums written was partially offset by a decrease in domestic property and casualty net written premiums.
Net earnings in 1996 increased $130 million, including an increase in after-tax net realized gains on investments of $20 million. Excluding after-tax net realized gains on investments, 1996 net earnings increased $110 million. This 1996 increase was primarily attributable to the Acquired Businesses reflecting a full year's operating results in 1996 compared to recording only five months of operating results in 1995. The remainder of the increase was due to improvement in the property and casualty underwriting results and growth in the investment portfolio due mostly from cash flows from international operations. These increases were partially offset by an increase in the effective tax rate due to a greater proportion of earnings before taxes provided by operations that reside in higher income tax jurisdictions.
Domestic net premiums written increased $68 million or 3.9% in 1997, reflecting new business associated with GE Capital's acquisition of Coregis Insurance Company and growth in the national accounts business partially offset by the termination of certain long-term disability business and continued competitive market conditions. Domestic net premiums written decreased $380 million or 18% in 1996, principally due to management's decision to not renew certain unprofitable reinsurance contracts and a slight decrease in reinsurance premium rates.
The GAAP combined ratio is an indicator of underwriting performance in property and casualty reinsurance, with a percentage lower than 100% indicating an underwriting profit. While underwriting results expressed as the combined ratio have been in excess of 100%, indicating an underwriting loss in all years presented, the operating results of insurance companies include investment income which generally yields an overall operating profit as reflected above in the caption "Earnings before income taxes, excluding net realized gains on investments." The 1997 GAAP combined ratio was favorably impacted by a reduction in catastrophe costs due to a decline in both frequency and severity of catastrophe losses, although it was moderately impacted by an increase in underwriting and operating costs due to the implementation of new strategic business initiatives. The 1996 and 1995 GAAP combined ratios were moderately impacted by catastrophe costs and certain significant unprofitable reinsurance contracts that management has elected not to renew.
International property and casualty net premiums written decreased $512 million or 23% in 1997, including approximately a $235 million decrease resulting from foreign currency translation due to the strengthening of the U.S. dollar. Excluding the impact related to foreign currency translation, international property and casualty net premiums written decreased approximately $277 million reflecting a $58 million increase in ceded premium as the Company expanded its retrocession program, repositioned certain portfolios to minimize loss accumulation and a general decrease in premium rates associated with competitive market conditions. International property and casualty net premiums written increased $1.194 billion in 1996, of which $1.203 billion reflects recording a full year of the Acquired Businesses operating results in 1996 compared to recording only five months of operating results in 1995. This increase was partially offset by a minor decrease in other international net premiums written, primarily due to the integration of international operations.
The 4.3% increase in the GAAP combined ratio for 1997 from 1996 was caused by less favorable loss experience, a general decline in international premium rates and market conditions and increased underwriting and operating costs associated with the implementation of new strategic business initiatives. The 1997 GAAP combined ratio was also adversely impacted by certain large catastrophe losses such as the Eastern Europe floods and aviation losses. The 3.7% improvement in the 1996 GAAP combined ratio compared to 1995 was caused by favorable loss experience and a decline in both the frequency and severity of international catastrophe losses.
Net investment income increased $26 million or 9.8% in 1997. This increase reflects continued growth in the investment portfolios related to the reinvestment of earnings, partially offset by the impact of foreign currency translation. Net investment income increased $141 million in 1996, primarily due to including $126 million related to recording a full year of the Acquired Businesses operating results in 1996 compared to recording only five months in 1995.
Earnings before income taxes increased $34 million in 1997, including a $20 million increase in net realized gains from investments. Excluding net realized gains on investments, earnings before income taxes increased $14 million primarily due to an increase in net investment income attributable to continued growth in the investment portfolio and fees generated from investment-related and financial reinsurance products. Earnings before income taxes increased $28 million in 1996, due primarily to the inclusion of a full year's operating results from the Acquired Businesses.
General. The Company follows a conservative investment strategy that emphasizes maintaining a high quality investment portfolio. The primary goals include a growing stream of investment income and improving total investment returns. All investments are administered under guidelines established and approved by the Company's Board of Directors. The Company's guidelines specify credit quality and concentration limits with respect to both fixed income and equity securities.
In normal operations, the Company must deal with effects of changes in interest rates and currency exchange rates. The following discussion presents an overview of how such changes are managed, a view of their potential effects, and, finally, what considerations arise from recent developments in Asia.
The Company manages its exposure to currency principally by matching the underlying reinsurance liabilities with the corresponding assets. Any remaining significant net asset/liability positions in a given currency are hedged with forward currency purchase or sale contracts to further mitigate currency exposures. The Company also hedges its currency risk on its foreign subsidiary investments by utilizing currency swaps that have been designated to modify currency exposure associated with specific debt instruments.
Substantially all derivative transactions are executed by the Company's Treasury Department which works closely with GE Capital Treasury personnel to maintain controls on all exposures, adhere to stringent counterparty credit standards and actively monitor marketplace exposures. Although the Company is exposed to credit risk that the counterparty may not be able to comply with the terms and conditions of the contracts, the Company utilizes only highly rated institutions as counterparties to the derivative transactions.
The Securities and Exchange Commission requires that registrants include information about potential effects of changes in interest rates and currency exchange in their financial statements. Although the rules offer alternatives for presenting this information, none of the alternatives is without limitations. The following discussion is based on so-called "shock-tests," which model effects of interest rate and currency shifts on the reporting company. Shock tests, while probably the most meaningful analysis permitted, are constrained by several factors, including the necessity to conduct the analysis based on a single point in time and by their inability to include the extraordinarily complex market reactions that normally would arise from the market shifts modeled. While the following results of shock tests for interest rates and currencies may have some limited use as benchmarks, they should not be viewed as forecasts.
One means of assessing exposure to interest rate changes is a duration-based analysis that measures the potential loss in net earnings resulting from a hypothetical decrease in interest rates of 100 basis points across all maturities (sometimes referred to as a "parallel shift in the yield curve"). Under this model, it is estimated that, all else constant, such a decrease, including repricing effects in the securities portfolio, would reduce the 1998 net earnings of the Company based on December 31, 1997 positions by an insignificant amount.
One means of assessing exposure to changes in currency exchange rates is to model effects on reported earnings using a sensitivity analysis. Year-end 1997 consolidated currency exposures, including financial instruments designated and effective as hedges, were analyzed to identify Company assets and liabilities denominated in other than their relevant functional currency. Net unhedged exposures in each currency were then remeasured assuming a 10 percent decrease (20 percent for hyperinflationary economies) in currency exchange rates compared with the U.S. dollar. Under this model, it is estimated that, all else constant, such a decrease would reduce the 1998 net earnings of the Company based on December 31, 1997 positions by an insignificant amount.
Recent economic developments in parts of Asia have altered somewhat the risks and opportunities of Company activities in affected economies. These activities encompass providing certain reinsurance products and investing in marketable securities within those Asian economies. As such, exposure exists to, among other things, increased receivable delinquencies and potential bad debts, impairment of marketable securities and increased reinsurance claims activity. Conversely, new reinsurance opportunities may arise and the liberalization of financial and reinsurance regulation may open new opportunities to penetrate Asian markets. Taken as a whole, while this situation bears close monitoring and increased management attention, the current situation is expected to have an immaterial impact on the Company's financial position, results of operations and cash flows in 1998.
The property and casualty reinsurance industry has been highly cyclical. Demand for reinsurance is significantly influenced by underwriting results of primary property and casualty insurance companies and prevailing general economic and reinsurance premium rates. The cyclical trends in the industry and the industry's profitability can also be affected significantly by volatile and unpredictable developments, including changes in what the Company believes to be the propensity of courts to grant large awards, natural disasters and other catastrophic events (such as hurricanes, windstorms, earthquakes, floods and fires), fluctuations in interest rates and other changes in the investment environment which affect inflationary pressures that may tend to affect the size of losses experienced by ceding primary insurance companies.
Year 2000 compliance programs and information systems modifications have been initiated in an attempt to ensure that these systems and key processes will remain functional. This objective is expected to be achieved either by modifying present systems using existing internal and external programming resources or by installing new systems, including enterprise systems, and by monitoring supplier and other third-party interfaces. While there can be no assurance that all such modifications will be successful, management does not expect that either costs of modifications or consequences of any unsuccessful modifications should have a material adverse effect on the Company's financial position, results of operations or liquidity.
The Financial Accounting Standards Board issued two Statements of Financial Accounting Standards (SFAS) that will affect presentation in the Company's 1998 Annual Report on Form 10-K. SFAS No. 130, Reporting Comprehensive Income, will require display of certain information about adjustments to equity - most notably, adjustments arising from market value changes in marketable securities. SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information, will require additional information about industry segments.