As mentioned in the Overview, the property-casualty insurance industry is in a downward cycle. However, despite a difficult year in which the Company aggessively strengthened its reserves, mangement expects that trend of in- creasing revenues and significant underwriting gains will continue in the future. The expansion of coverages and entry into new geographic regions has contributed to increased revenues, which when combined with prudent under- writing standards should enable the Company to resume its upward trend in profitability for our shareholders. Indeed, when the industry's cycle re- verses, the Company will be in an excellent position to take advantage of premium rate increases.
Gross premiums written during 1997 were $99,507,846, compared with $90,939,387 in 1996 and $70,878,492 in 1995.
Premiums earned are recognized as net revenues after reduction for reinsurance ceded and after establishment of the provision for the pro rata unearned portion of premiums written. Net premiums earned in 1997 totaled $87,451,620, compared with $77,347,319 and $63,865,500 in 1996 and 1995, respectively. The net unearn- ed premium reserve was $47,411,849, $43,258,833 and $31,555,728 at each year- end.
The Company's fixed maturities and equity securities are classified as available-for-sale and are carried at fair value. The unrealized gains and losses, net of tax, are reported as a separate component of shareholders' investment.
Income tax expense is based on income reported for financial statement purposes and tax laws and rates in effect for the years presented. Deferred federal in- come taxes arise from timing differences between the recognition of income de- termined for financial reporting purposes and income tax purposes. Such timing differences are related principally to the deferral of policy acquisition costs, the recognition of unearned premiums, and discounting the claims reserves for tax purposes. Deferred taxes are also provided on unrealized gains and losses.
Reserves for losses and loss adjustment expenses reflect the Company's best estimate of the liability for the ultimate cost of reported claims and incurred but not reported (IBNR) claims as of the end of each period. The estimates are based on past claim experience and consider current claim trends as well as social and economic conditions. The Company's reserves for losses and loss ad- justment expenses were $71,472,338 at December 31, 1997 compared with $47,702,363 at December 31, 1996. This increase is a combination of giving con- sideration for the increase in premium volume, increased retention on all lines of coverages written and an increase in the IBNR reserves. Management continues to closely monitor the reserve development trends and projections as it attempts to stabilize the loss reserve development which has occurred in recent years.
Liquidity refers to the Company's ability to meet obligations as they become due. The obligations and cash outflow of the Company include claim settlements, acquisition and administrative expenses, investment purchases and dividends to shareholders. In addition to satisfying obligations and cash outflow through premium collections, there is cash inflow obtained from interest and dividend income, maturities and sales of investments. Because cash inflow from premiums is received in advance of cash outflow required to settle claims, the Company accumulates funds which it invests pending liquidity requirements. Therefore, investments represent the majority (85.7% in 1997, 80.7% in 1996 and 84.4% in 1995) of the Company's assets. Cash outflow can be unpredictable for two reasons: first, a large portion of liabilities representing loss reserves have uncertainty regarding settlement dates; and second, there is potential for losses occurring either individually or in the aggregate. As a result, the Com- pany maintains adequate short-term investment programs necessary to ensure the availability of funds. The investment program is structured so that a forced sale liquidation of fixed maturities should not be necessary during the course of ordinary business involvement and activities. The Company has no material capital expenditure commitments.
A significant issue facing not only the insurance industry but society as a whole is potential problems related to the approaching year 2000. Older computer programs were written using two digits rather than four to define the applicable year. As a result, those computer programs may misinterpret a date, using "00" as the year 1900 rather than year 2000.
The Company has also assessed the potential impact of year 200 related problems that may be encountered by our agents and third parties, and determined that any impact would not be material relative to the operations of the Company. However, there can be no guarantee that actual results would not differ materially from those anticipated.