The historical financial information for the five years ended December 31, 2000 and at December 31, 2000, 1999, 1998, 1997 and 1996 has been derived from the audited Consolidated Financial Statements of the Company. The selected consolidated financial data set forth below is qualified in its entirety by reference to and should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," and the Company's Consolidated Financial Statements and the Notes thereto included elsewhere in this Form 10-K.
The following discussion analyzes significant items affecting the results of operations and the financial condition of the Company. In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Company cautions readers regarding certain forward-looking statements contained in this report and in any other statements made by, or on behalf of, the Company, whether or not in future filings with the Securities and Exchange Commission (the "SEC"). Forward-looking statements are statements not based on historical information and which relate to future operations, strategies, financial results, or other developments. Statements using verbs such as "plan", "anticipate", "believe", "expect" or words of similar import generally involve forward-looking statements. Without limiting the foregoing, forward-looking statements include statements which represent the Company's beliefs concerning future levels of sales and surrenders of the Company's products, investment spreads and yields, or the earnings and profitability of the Company's activities.
The following table summarizes the Company's sales in terms of collected first year premiums over the three-year period ended December 31, 2000.
Similar reconciling items had the effect of increasing income before income taxes by $20.7 million from 1998 to 1999. The primary reasons for the increase were (i) a $14.8 million increase in net realized investment gains not allocated to segments, (ii) a $3.7 million increase in net investment income related to a reduction in the unrecovered ceding commission due to the Reinsurer, (iii) a $5.9 million decrease in advisory and data processing fees paid to FHC, and (iv) a $6.8 million decrease in expenses not allocated to specific segments, offset by (v) a $4.9 million gain from the sale of a subsidiary in 1998 and (vi) expenses related to costs associated with litigation in 1999.
Policyholder benefits. Policyholder benefits totaled $261.2 million in 2000 compared with $261.3 million in 1999. Excluding the effect of the payroll-deduction business, policyholder benefits increased $13.7 million from 1999 to 2000. This increase resulted primarily from (i) a $12.7 million increase in interest credited on universal life and annuity fund balances, (ii) a $4.3 million increase in other policyholder benefits and (iii) a $6.6 million decrease in reserve reduction, offset by (iv) a $10.0 million decrease in death benefits.
Other operating expenses. Other operating expenses totaled $84.4 million in 2000 compared with $91.0 million in 1999. During 2000, the Company reviewed the levels of general expenses in all of its operating and corporate departments. The Company identified sources of expense savings through increased cost controls which have reduced expenses by $3.9 million. Other operating expenses also decreased due to lower expenses related to the Company's AFS marketing operations. In both 2000 and 1999, other operating expenses included $5.0 million of costs associated with litigation.
Income before income taxes increased $4.2 million to $16.2 million in 1999. The primary reasons for the increase were (i) lower advisory and data processing fees paid to FHC in 1999 and (ii) an increase in net realized gains in 1999, offset by (iii) a gain on the sale of Investors Guaranty in 1998, and (vi) higher death benefits in 1999. These items and significant changes in individual income statement components are discussed in more detail below.
The increase related to the Company's mortgage loan portfolio is due to an increase in the average mortgage loan balance from $189.8 million in 1998 to $218.1 million in 1999. This increase is partially offset by a decrease in the average yield of the portfolio from 1998 to 1999.
Net realized investment gains. Net realized investment gains totaled $4.2 million in 1999 compared with $8.3 million in 1998. The Company reported $0.9 million and $16.7 million of realized gains from the sale of fixed maturity investments held by the Reinsurer in 1999 and 1998, respectively. As described below, the sale of fixed maturity investments held by the Reinsurer resulted in increased amortization of cost of business acquired assets. Excluding the effects of these gains, the Company realized gains of $3.3 million in 1999 and realized losses of $8.4 million in 1998; this change in realized gains can be attributed to a $16.5 million increase in gains on common stock, offset by a $1.4 million decrease in gains on fixed maturity investments and $3.3 million of gains in 1998 related to real estate investments.
Included in 1998 realized losses of $8.4 million was $6.0 million of realized losses on short positions held on common stocks owned by the Company. There was a like amount of increase in market value on the related long position of the common stocks which was included in unrealized gains in stockholders' equity. In 1999, the Company realized gains of $0.6 million on short positions held on common stocks.
Liquidity. The liquidity needs of Americo, whose principal assets are investments in its insurance subsidiaries, are dependent upon receipt of sufficient funds from its subsidiaries. The cash requirements of Americo consist of debt service requirements on notes payable, amounts due to FHC under advisory and data processing agreements and its own operating expenses. These cash requirements are met by payments of principal and interest on surplus debentures that Americo holds which are issued by United Fidelity and dividends from United Fidelity. Americo also receives payments under investment advisory and data processing agreements with the insurance subsidiaries which permit Americo to recover a portion of the amounts paid by it under similar agreements with FHC. On a stand-alone basis, at December 31, 2000, Americo had $33.7 million of cash and marketable equity securities available for debt service and other corporate requirements. During 1999, Americo repaid the $21.0 million then outstanding under a credit facility using available cash and $12.3 million of dividends received from the life insurance subsidiaries. This credit facility was terminated during 1999.
The surplus debentures contain restrictions which prevent United Fidelity from making principal and interest payments if such payments reduce United Fidelity's statutory capital and surplus below an amount specified in the surplus debenture agreements. The most restrictive minimum surplus requirement contained in the surplus debentures is $37.5 million; United Fidelity's capital and surplus at December 31, 2000 was $92.0 million. Any future payment of principal or interest on such surplus debentures will be limited by the ability of the subsidiaries of United Fidelity to pay dividends to United Fidelity and may be further limited by United Fidelity's RBC requirements. See "Business Regulation". The Company does not believe that United Fidelity will have any difficulty in meeting its obligations under these surplus debentures in the foreseeable future.
In order to meet its obligations under the surplus debentures, United Fidelity uses funds generated by its insurance operations and dividends from its insurance subsidiaries. The ability of the insurance subsidiaries to pay dividends is subject to regulatory restrictions. The insurance holding company statutes of Texas, in which the Company's insurance subsidiaries are domiciled, regulate payment of dividends by an insurance company to its parent. Generally, without the consent of the state's insurance commissioner, an insurance company may not pay dividends to its parent in excess of the greater of (i) the insurer's prior year statutory net gain from operations, or (ii) 10% of its prior year ending statutory capital and surplus, subject in either case to sufficient earned statutory surplus from which such dividends may be paid. Additionally, an insurance company is required to notify the respective insurance department prior to the payment of ordinary dividends.
Financial condition. Stockholder's equity increased to $254.7 million at December 31, 2000 from $225.3 million at December 31, 1999. The increase was the result of net income of $14.9 million and an increase in net unrealized investment gains of $16.5 million, offset by $2.0 million of dividends to FHC. Net unrealized investment gains in 2000 were recorded due to an increase in the market value of the Company's available for sale fixed maturities and equity securities. See Note 4 to the Company's Consolidated Financial Statements included elsewhere in this Form 10-K for further discussion of the components of the change in net unrealized investment gains.
The Company continually reviews its non-investment grade debt securities (NAIC designations 3 through 6) for evidence of declines in value which are other than temporary. The Company does not anticipate any material increase in its investments in non-investment grade debt securities. At December 31, 2000, the Company's investment portfolio contained no securities which were in default as to principal or interest.
The Company manages the yield and cash flow variability of its MBS portfolio by (i) purchasing securities backed by collateral with lower prepayment sensitivity (such as mortgages priced at a discount to par value), (ii) avoiding securities whose values are heavily influenced by changes in prepayments (such as interest-only and principal-only securities) and (iii) concentrating on securities with prepayment protected structures (such as planned amortization class CMO's). See Note 4 to the Company's Consolidated Financial Statements included elsewhere in this Form 10-K for a summary of the Company's investments in CMO's.
At December 31, 2000, the Company's investment portfolio included $268.9 million of mortgage loans, which were collateralized primarily by multi-family apartments, office buildings and retail properties located in 30 states. Approximately 28% of the portfolio was multi-family apartments, 20% was office buildings, 28% was industrial properties and 24% was other types of properties. At December 31, 2000, approximately 20% of the mortgage loan portfolio was secured by properties in Texas, 14% in Missouri and 11% in Kansas. No more than 10% of the remaining portfolio was secured by properties in any one state.
At December 31, 2000, 0.7% of the mortgage loan portfolio consisted of loans with balloon payments that mature before January 1, 2002. At December 31, 2000, mortgage loans delinquent by more than 90 days, as determined on a contract delinquency basis, totaled approximately $0.3 million, which constituted 0.2% of mortgage loans and was 0.01% of cash and invested assets. There were no loans foreclosed upon and transferred to real estate owned in the Company's consolidated balance at December 31, 2000. The favorable default experience is principally attributed to the Company's selectivity in the purchase of mortgages in connection with acquisitions of its life insurance subsidiaries and its origination of new mortgage loans. In light of the current market interest rate environment, the Company may experience prepayments on its mortgage loan portfolio, thus reducing its yield on such portfolio. The Company plans to continue applying its historical underwriting standards to future investments in mortgage loans.
The Company sells equity-indexed life insurance and annuity products. These products include an interest credit component, which is based on changes in the Standard and Poor's 500 Index ("S&P Index"). In order to hedge its exposure to changes in the S&P Index, the Company purchases call options and futures contracts on the S&P Index.
All derivatives are recognized on the balance sheet at their fair value. Realized or unrealized gains and losses on derivative instruments are recognized as current income. At December 31, 2000, the fair value of derivatives totaled $0.9 million. The Company recognized $1.3 million in realized and unrealized losses in 2000. These losses were offset by a like decrease in the market value of the policyholder account balance.
Because of the restrictions described above under "Financial Condition and Liquidity-Liquidity" in surplus debentures and holding company statutes, an adverse outcome in the litigation referred to above could affect the ability of one or more of the Company's insurance subsidiaries to pay dividends or, in the case of United Fidelity, make payments under its surplus debentures to the Company. Further, were a subsidiary to suffer an adverse outcome, the Company might need to contribute capital to such subsidiary so that it could continue to maintain applicable statutory surplus and risk-based capital requirements. See "Business-Regulation-General Regulation and Risk-Based Capital Requirements". Because the Company is a holding company whose own cash and cash equivalents are limited, the Company might have to dispose of some of its assets in order to address a significant judgment suffered by it or one of its subsidiaries. Also, an adverse outcome could affect ratings which the Company's subsidiaries receive from rating agencies, which could affect their ability to compete. See "Business - -Competition and Ratings".
Management is aware that prevailing interest rates may shift significantly and has strategies in place to manage either an increase or decrease in interest rates. In a rising interest rate environment, the Company's cost of funds would increase over time as it prices its new and existing interest-sensitive and investment products to maintain generally competitive market rates. Management would seek to invest new and renewal premiums in investments which are high yielding and generally correspond to the duration of its liabilities. Management believes that liquidity to fund withdrawals would be available through a combination of incoming cash flow, the sale of short-term or floating-rate instruments, and maturing short-duration assets thereby avoiding the sale of significant amounts of longer duration fixed-rate assets in an unfavorable bond market. In a declining rate environment, the Company's cost of funds would decrease over time, reflecting lower interest crediting rates on its interest-sensitive liabilities. The Company's interest-sensitive liabilities carry minimum interest guarantees, which may cause the reduction in the Company's cost of funds to be less than the overall decrease in market interest rates. In addition, redemptions of callable fixed-rate investments would likely increase in this environment, causing the Company to reinvest funds at lower yields. In order to mitigate this risk, the Company has reduced its investment in callable securities. Should increased liquidity be required for withdrawals, management believes that a significant portion of its investments could be sold without adverse consequences in light of the general strengthening which would be expected in the bond market.
The Company's audited consolidated financial statements for the three years ended December 31, 2000 and the related report of independent accountants thereon are set forth at pages to hereof and are incorporated herein by reference. Reference is made to the Index to Financial Statements on page herein.