The following summary sets forth selected financial data with respect to AIIG for the five fiscal years ended December 31, 1998. The balance sheet and income statement data have been derived from AIIG's consolidated financial statements, which have been audited by Johnson Lambert & Co., AIIG's independent auditors. The data set forth below should be read in conjunction with the audited financial statements and notes thereto included elsewhere herein.
Net income increased by 20% in 1998 to $1,601,672 from $1,331,171 in 1997. Net income for 1997 decreased by 36% from $2,086,778 reported in 1996.
Premiums earned increased by 20% in 1998 to $7,046,551 from $5,852,286 in 1997. Premiums earned for 1997 increased by 9% from $5,386,388 reported in 1996. In 1998, 1997, and 1996 premiums earned includes $131,250, $720,298 and $693,976, respectively resulting from reductions in the ultimate estimated premium ceded pursuant to retrocession agreements in effect during 1989 through mid-1993. Ultimate premiums are dependent on loss experience under the agreements and are reevaluated as ultimate losses are reevaluated. Excluding the effect of the reduction of estimated ultimate premiums ceded, premiums earned during 1998 increased by 35% as compared to 1997; 1997 premiums earned increased by 9% as compared to 1996, and 1996 premiums earned decreased by 4% from 1995.
Average invested assets including cash equivalents increased by $2,007,639 or 5% to $43,382,384 in 1998 compared to $41,374,745 in 1997. 1997 average invested assets increased by 3% from $40,077,308 in 1996. Investment yield including realized capital gains and losses in 1998 was 5.6% as compared to 6.2% in 1997 and 6.0% in 1996. Excluding realized gains and losses, the yield is computed at 5.0% in 1998, 5.5% in 1997 and 6.0% in 1996. The decrease in investment yield, excluding realized gains and losses, is primarily attributable to an increase in holdings of tax free municipal securities and an increase in equity securities which generate less realized investment income.
Unrealized gain on investments net of tax is $1,156,993 at December 31, 1998 as compared to $1,016,956 at December 31, 1997. AIIG considers all of its investment portfolio to be available for sale and accordingly all investments are reported at market value, with changes in net unrealized gains and losses reflected as an adjustment to accumulated other comprehensive income.
The composition of the investment portfolio at December 31, 1998 and 1997 is as follows:
recent years. Additionally, in recent years, many of the CNA insureds have opted to purchase defense coverage outside of policy limits which result in larger reserve requirements.
Operating and management expenses increased by 4% in 1998 to $642,925 from $619,684 in 1997. 1997 operating and management expenses decreased by 15% from $727,780 in 1996.
AIIG is aware of the issues associated with the programming code in existing computer systems as the year 2000 approaches. The "Year 2000" problem is the result of computer programs being written using two digits rather than four to define the applicable year. Programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. Systems that do not properly recognize such information could generate erroneous data or fail.
VIM has not yet received responses to all of its third party inquiries, but the Company believes that its primary focus regarding the Year 2000 problem is appropriately with AIIC's primary insurance carrier, CNA. The majority of insurance transactions affecting the Company are originated by CNA operating systems, with quarterly reporting to the Company. Representatives of CNA have informed the Company that CNA has been Year 2000 compliant since December 1, 1998. If CNA is not Year 2000 compliant, the Company believes that the impact on its business is likely to be material. Presently, the Company's only business is that of reinsurance, so the Company anticipates that Year 2000 noncompliance by, particularly CNA, will be disruptive primarily from a reporting and informational standpoint.
AIIG's gross premiums written in 1998 amounted to $7,521,837 (also see discussion of premiums earned in Results of Operations), an increase of $1,724,761 from 1997. Gross premiums written in 1997 increased by $1,056,099, or 22.3% from 1996. Assumed reinsurance premiums receivable represents current assumed premiums receivable less commissions payable to the fronting carriers. This balance increased from $1,146,379 at December 31, 1997 to $2,357,147 at December 31, 1998, an increase of 106%. Approximately $818,000 of the increase in assumed reinsurance premiums receivable is attributable to the one-time adjustment for prior year premiums due from CNA, as more fully described in Results of Operations. This balance also fluctuates due to the timing of renewal premium written. The increase in premiums has also resulted in a direct increase in policy acquisition costs, unearned premiums, fixed commissions paid to CNA as part of its quota share agreement, and loss reserves.
During 1998, 1997 and 1996, the Board of Directors declared quarterly dividends of $0.65 per share totaling $865,587, $867,735 and $869,661, respectively. Continuation of quarterly dividend payments is subject to the Board of Directors' continuing evaluation of the Company's level of surplus vis a vis its capacity to accept more business. It is an objective of the Company to build surplus in anticipation of the next "hard market", that is to say, the next period in which accountants' professional liability insurance becomes difficult or impossible to obtain at reasonable prices, and to retain flexibility for any future business expansions.
The anticipated effect of inflation is implicitly considered when estimating liabilities for losses and LAE. Future average severity is projected based on historical trends adjusted for anticipated changes in underwriting standards, policy provisions and general economic trends. These anticipated trends are monitored based on actual development and are modified if necessary.
As is customary in the business, an acturial review and projection is performed for AIIC by its independent actuary as of June 30 and December 31 of each year. Those projections are not adjusted at the first or third quarters, but remain in effect for the half-year period.
The selection of estimated ultimate loss, and related loss ratios, for each of the last five years consistently have been based on composite indications from each of the four methods rather than solely on a single method. However, for more recent and thus most immature report years, the selection has primarily been based on the Trended Average Cost Method, which adjusts quickly to changes in the number of reported claims which become available soon after the end of the report year.
Based on the foregoing practice, the estimated loss ratio has been changed by AIIG's Board of Directors approximately once each year, including the recent decrease from 120% to 100%. The reason for that change is that the Board, following receipt of the actuary's report, determined that the 120% ratio was too high, based on the circumstances and available information.
The above table presents the development of balance sheet liabilities for 1988 through 1998 as of year-end 1998. The top line of the table shows the original recorded unpaid liability for losses and LAE recorded at the balance sheet date for each of the indicated years.
This liability represents the estimated amount of losses and LAE for claims arising in all prior years, both paid and unpaid at the balance sheet date, including losses that had been incurred. The upper portion of the table shows the experience as of the end of each succeeding year. The estimate is increased or decreased as more information becomes known about the frequency and severity of claims.
In evaluating this information, it should be understood that each amount includes the effects of all changes in amounts for prior periods. This table does not present accident or policy year development data, which readers may be more accustomed to analyzing. Conditions and trends that have affected development of liability in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on this table.
See Note F to the Consolidated Financial Statements regarding the codification of statutory accounting practices by the National Association of Insurance Commissioners.