(b) Loss and loss adjustment expense for 1996 excludes discontinuation of loss reserve discounting which is reported as a cumulative effect of a change in accounting principle.
The following discussion and analysis should be read in conjunction with the consolidated financial statements and the notes thereto included elsewhere in this report. The following discussion contains certain forward-looking statements relating to our anticipated future financial condition and operating results and our current business plans. In the future, our financial condition and operating results could differ materially from those discussed herein and our current business plans could be altered in response to market conditions and other factors beyond our control. Important factors that could cause or contribute to such differences or changes include those discussed elsewhere in this report. See the disclosures under "Item 1 -- Business -- Uncertainties Relating to Forward-Looking Statements."
We use reinsurance treaties to increase underwriting capacity in terms of both large line capacity and premium capacity. The net retention and treaty limits for both professional liability ($500,000 retention) and workers compensation (coverage up to the full statutory limits above the $500,000 retention) capture almost all of our capacity requirements. These reinsurance arrangements allow us to provide policy limits as required by the marketplace, without retaining an unreasonable amount of risk. We are also able to enter new markets without a complete burden on our surplus. This was the case in Florida, where through 1999 we maintained a 50% quota share reinsurance arrangement. Our level of reinsurance participation varies by line of business and, in some cases, by geographic market. During 2000, we ceded approximately 8.3% of medical professional liability premiums, 5.0% of workers' compensation premiums, 13.2% of personal and commercial premiums and 42.4% of health premiums.
primarily from retroactive premium adjustments relating to audits of covered compensation, as well as selected rate increases.
Net premiums earned increased by $31.7 million, or 21.3%, to $180.3 million in 2000. This increase reflects the increase in direct premiums written and changes in our reinsurance program, primarily eliminating the 50% quota share arrangement in Florida and retaining a larger portion of the health insurance business.
On a line of business basis, the medical professional liability loss ratio for 2000 was 87.6% as compared to 86.5% for 1999. The medical professional liability loss ratio increase was due to higher losses in some of our newer markets, particularly Ohio and Florida. The workers' compensation loss ratio was 80.3% in 2000 compared to 79.5% in 1999. The slight increase in the workers' compensation loss ratio was the result of increased losses, partially offset by rate increases. The personal and commercial loss ratio was 76.7% in 2000 and 81.9% in 1999, and the health loss ratio was 90.6% in 2000 and 199.3% in 1999. The 1999 personal and commercial loss ratio reflected higher winter storm losses. The 1999 health loss ratio was adversely affected by a one-time reserve establishment.
The overall underwriting expense ratio improved to 23.4% in 2000 from 26.9% in 1999. Medical professional liability policy acquisition and underwriting were $20.6 million in 2000 compared to $22.2 million in 1999. As a percentage of premiums earned, the medical professional liability underwriting expense ratio decreased to 18.8% in 2000 from 23.0% in 1999. This decrease was due primarily to expense reduction measures that we began implementing in the fourth quarter of 1999 and the acquisition of the management company in 1999.
We recorded $4.8 million in federal income tax expense in 2000, compared to a refund of $23.8 million in federal income taxes during the same period in 1999. The effective tax rate was 28.7% in 2000, compared to (238.3%) in 1999. In 1999, we received a significant settlement with the IRS regarding the tax treatment of reserves.
Direct premiums written increased $29.3 million or 18.3% in 1999 to $189.6 million. This increase was generated by all product lines. Medical professional liability direct premiums written totaled $122.9 million in 1999, up $12.6 million or 11.5%. The largest growth was in Florida, up $7.0 million, or 101%, and Illinois, which was up $5.8 million, or 67%. The increase in both of these markets reflects the continued growth in relatively new markets entered into by APAssurance. Our core Michigan business was down $2.8 million, or 5.6%, to $46.6 million, due to rate increases, price competition and physician practice consolidation.
On a net basis, premiums increased to $158.0 million, up $10.2 million or 6.9% from 1998. There are two primary reasons that the increase in net premiums written is so much lower than the increase in direct premiums written. First, there was an increase in the proportion of business from markets and products where we cede more premiums, principally Florida medical professional liability (50% ceded) and health insurance nationally (80% ceded). Second, there was a $5.1 million increase in ceded premiums in 1999 due to an unfavorable adjustment in the swing-rated reinsurance program resulting from prior year loss activity. This compares to a favorable adjustment in 1998 of $3.7 million, which reduced the 1998 ceded premium. Net premiums earned increased $11.7 million, or 8.5%, to $148.7 million. The difference in growth rate between net written and net earned premiums primarily reflected the timing of adding new premiums to the book of business.
Losses and loss adjustment expenses increased $8.9 million, or 7.3%, to $130.9 million in 1999. The 1999 reported loss ratio was 88.1% as compared to 89.1% in 1998. The accident year loss ratio, which excludes the effects of prior year developments of loss reserves, was 101.7% in 1999 compared to 103.8% in 1998. We began to see a decline in both the calendar year reported loss ratio and the accident year loss ratio in 1999. These decreases are primarily the result of rate increases and a change in the mix of business. The reported loss ratio is lower than the accident year loss ratio for both years as a result of favorable development of prior year reserves. Our reported loss ratio has consistently been less than our accident year loss ratio due to the inherent uncertainty of medical professional liability claims and our conservative reserving philosophy. In the period of notice, claims are reserved based on our estimates of their potential outcome, given the nature and severity of the case. However, many of our claims have ultimately resulted in lower losses than initially estimated.
When we enter a new market we tend to be conservative in establishing our reserves due to our limited history in the local court system. In addition, because we do not have sufficient company-specific data for projecting reserves, we utilize industry loss data in the applicable state to establish reserves for incurred but not reported claims. To the extent these assumptions prove to be different than our actual experience, subsequent reserve adjustments are necessary. The recent growth of our medical professional liability business into new markets has increased this subsequent reserve adjustment activity. It usually takes several years to determine the ultimate loss ratio for any given accident year.
our Michigan business and rate increases taken in several markets. The workers' compensation loss ratio was 79.5% in 1999 compared to 80.7% in 1998. The personal and commercial loss ratio was 81.9% in 1999 and 92.7% in 1998, and the health loss ratio was 199.3% in 1999 and 78.7% in 1998. The 1999 health loss ratio was adversely affected by a one-time reserve establishment.
In late 1999, we began a process of reengineering our operations to increase efficiencies and reduce costs by closing two small offices in Indianapolis, Indiana and Columbus, Ohio. These actions were the first phase of the restructuring of our staff. A total of 35 people, primarily clerical staff, were terminated at the time of the restructuring. These events caused a $955,000 charge in 1999, including $802,000 of severance compensation, $79,000 in office closure cost, and $74,000 in outplacement services.
Net investment income of $27.3 million in 1999 represented an increase of $0.8 million or 3.0% over the $26.5 million earned in 1998. The increase was the result of a larger invested portfolio. Our current return on investments, excluding changes in market value, was 5.59% in 1999 as compared to 5.64% in 1998. Investment income also included $1.1 million in 1999 from rental income on investment real estate.
Realized gains were $1.8 million in 1999, down $7.7 million from 1998. The 1998 results were unusually large due to the transitioning of the equity portfolio to new investment managers. The new managers significantly restructured the portfolio, triggering a large amount of realized gains.
Our net cash flow from operating activities was approximately $70.0 million for 2000, primarily due to the receipt of an income tax refund and related interest totaling $39.2 million and net income of $11.9 million. We invest our positive cash flow from operations in both fixed maturity securities, including short-term investments and equity securities. Our investment strategy seeks to maximize after-tax income through a high quality, diversified, duration sensitive, taxable bond and tax-preferenced municipal bond portfolio, while maintaining an adequate level of liquidity and a modest level of investment in equity securities.
APCapital itself is a holding company whose only material assets are the capital stock of APAssurance and its other subsidiaries and a portion of the net proceeds from the stock offerings completed in December 2000. APCapital is using these funds to finance its long- and short-term liquidity needs, which include operating expenses, financing future acquisitions, and may include making additional contributions to its subsidiaries. APCapital's ongoing cash flow will consist primarily of dividends and other permissible payments from its subsidiaries and investment earnings on funds held. The payment of dividends to APCapital by its insurance subsidiaries is subject to limitations imposed by applicable law. APAssurance's ability to pay dividends to APCapital is influenced by a variety of factors, including cyclical changes in the medical professional liability insurance market, APAssurance's financial results, insurance regulatory changes, including changes in the limitations imposed by the Michigan Holding Company Systems Act on the payment of dividends by APAssurance and changes in general economic conditions.
We consider the effects of inflation on our business in estimating our reserves for unpaid losses and loss adjustment expenses, and in the premium rate-making process. The actual effects of inflation on our operations cannot be accurately known until the ultimate settlement of claims. However, based upon the actual results reported to date, it is our opinion that our loss reserves, including reserves for losses that have been incurred but not yet reported, adequately provide for the effects of inflation.
RML Insurance Company -- a stock insurance company incorporated under Illinois law (RML).
APDirect Sales -- a Michigan corporation that serves as APCapital's direct sales channel.