Net earnings decreased $59 million or 8% in 1999, including an increase in after-tax net realized gains on investments of $176 million. Excluding after-tax net realized gains on investments, net earnings decreased $235 million or 46% in 1999. This decrease was primarily attributable to increased property and casualty-related losses related to the frequency and severity of large loss events occurring in 1999 as compared to 1998 and, to a lesser extent, adverse development on prior year recorded losses. Large loss events are individual events that, after specific reinsurance recoveries and related premium adjustments, affect operations by $2 million or more, and include losses from earthquakes, aviation or railroad accidents, fire damage, and weather-related damage from hurricanes, tornadoes, wind and ice. Large loss events amounted to approximately $720 million in 1999, as compared to $230 million in 1998. A portion of the 1999 losses was recovered under aggregate excess retrocession coverages obtained in the ordinary course of business. This increase in property and casualty-related losses was partially offset by a $166 million increase in net investment income, primarily due to growth in the investment portfolio as a result of acquisitions, and a $134 million increase in other revenues, primarily due to acquisitions, equity-method investments and a gain on disposition of the Company's reinsurance brokerage subsidiary. An increase in underwriting and operating expenses associated with acquisitions and continued competitive market conditions also contributed to the deterioration in underwriting results. Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
The significant increase in the combined ratio in 1999 reflects an increase in the frequency and severity of large loss events occurring in 1999 and, to a lesser extent, adverse development on prior year recorded losses. The lower combined ratio in 1998 primarily reflects a general reduction in incurred losses caused by a decline in both the frequency and overall severity of claims, partially offset by an increase in hurricane and other weather-related catastrophe losses.
Earnings before income taxes, excluding net realized gains on investments, decreased $273 million in 1999, primarily attributable to the significant increase in the combined ratio, partially offset by the increase in net investment income discussed above. Earnings before income taxes, excluding net realized gains on investments, increased $13 million or 5% in 1998, primarily attributable to the decrease in the combined ratio and the increase in net investment income discussed above.
Net investment income increased $54 million or 19% in 1999, primarily attributable to the acquisitions of GE Re and Eagle Star Re. Net investment income decreased $6 million or 2% in 1998, primarily attributable to market conditions partially offset by the acquisition of GE Re.
Earnings before income taxes increased $87 million or 55% in 1999, including a $48 million increase in net realized gains on investments. Excluding net realized gains on investments, earnings before income taxes increased $39 million or 32% in 1999, primarily attributable to an increase in net investment income, primarily due to continued growth in the investment portfolios, and fees generated from investment-related life reinsurance products and financial reinsurance transactions. Earnings before income taxes increased $5 million or 3% in 1998, including a $9 million decrease in net realized gains on investments. Excluding net realized gains on investments, earnings before income taxes increased $14 million or 13% in 1998, primarily attributable to an increase in net investment income, primarily due to continued growth in the investment portfolios, and fees generated from investment-related life reinsurance products and financial reinsurance transactions.
GE Global Insurance's ability to meet its obligations, including debt service and operating expenses, and pay dividends to its shareholder depends primarily upon its receipt of sufficient funds from its insurance subsidiaries. The payment of dividends by ERC, GE Re and Medical Protective are subject to restrictions set forth in the insurance laws of Missouri, Illinois and Indiana, respectively, as well as other restrictions. Historically, the Company's liquidity requirements have been met by funds provided from operations and from the maturity and sales of investments.
offset by the change in contract deposits associated with the commutation of a financial reinsurance treaty and an increase in dividends paid to affiliates.
As of December 31, 1999, the Company had a $625 million note payable to GE Capital Corporation (which carries an annual interest rate equal to GE Capital Corporation's cost of funds) under an interim loan agreement that was used to fund its acquisition of Medical Protective.
On a worldwide basis, based on data as of December 31, 1999, the Company manages 68% of its investments internally. General Electric Investment Corporation manages an additional 16% of the Company's investments, and the balance is managed by unaffiliated outside managers.
The significant decrease in unrealized gains on investment securities before deferred income taxes in 1999 is primarily due to the concentration of fixed maturity debt securities held in the investment portfolio and the effects of a general rise in interest rates which occurred during 1999.
Domestic Investment Operations. The Company's domestic property and casualty investment portfolios are principally invested in tax-exempt state and municipal bonds, which the Company believes provide the most attractive after-tax yield. Some additional commitment was made to equity securities in recent years to enhance total investment returns in the longer term. The Company's domestic life investment portfolios are largely invested in taxable debt securities.
The Company's domestic fixed maturity portfolios categorized by rating based on market values are summarized as follows:
The Company's emphasis on investment quality is evidenced by the preceding table, which indicates that the bonds in the Company's investment portfolios are principally invested in either U.S. government and government agency securities or issues rated "A" or above. The Canadian securities held by the Company are similar in quality to the other securities held in its domestic property and casualty portfolio. Fixed maturity securities held by the Company in its domestic life portfolios include mortgage-backed and other asset-backed securities that are matched to the liability profile of specific life reinsurance contracts. Investments in mortgage-backed and other asset-backed securities are limited to lower risk tranches and do not include any interest only or principal only elements. Mortgage-backed and other asset-backed securities in the Company's investment portfolio were principally issued by Federal agencies. The majority of the balance of other securities held in both the domestic property and casualty and domestic life portfolios represent investments in non-rated debt securities. The Company does not contemplate significant additional investment in non-investment grade securities in either the property and casualty or life portfolios.
Most fixed maturity securities within the ERC Frankona Group's investment portfolios have a term of less than ten years. The fixed maturity securities consist of high credit quality securities, and almost all bonds are investment grade securities with a comparable average rating equal to or above a Moody's or S&P "AA" rating. Fixed maturity securities include German and Danish mortgage-backed securities, although these mortgage-backed securities have significantly less prepayment risk than typical U.S. mortgage-backed securities, as the German and Danish tax and social environments are not conducive to risks of prepayment of interest and principal. Equity securities and other invested assets were internationally diversified with principal holdings in Germany, the United Kingdom and the United States.
Interest rate and currency risk management is important in the normal operations of the Company. The following discussion presents an overview of such management.
The Company uses various financial instruments, such as currency and interest rate swaps, options and currency forwards, principally to manage interest rate and currency risks. The Company is exclusively an end-user of these instruments, which are commonly referred to as derivatives. The Company does not engage in trading, market-making or other speculative activities in the derivatives markets. Management requires that derivative financial instruments relate to specific asset, liability or equity transactions or to currency exposures. More detailed information about these financial instruments, as well as the strategies and policies for their use, is provided in Notes 2 and 14 to the consolidated financial statements.
On a limited basis, and as part of ongoing customer activities, the Company uses interest rate swaps and options to minimize its exposure to movements in interest rates and financial markets that have a direct correlation with certain of its reinsurance products.
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 uses only highly rated institutions as counterparties to the derivative transactions.
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 2000 net earnings of the Company based on year-end 1999 positions by an insignificant amount. Based on positions at year-end 1998, the pro forma effect on 1999 net earnings of such a decrease in interest rates was also estimated to be 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 1999 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 have had an insignificant effect on the 2000 net earnings of the Company based on year-end 1999 positions. Based on conditions at year-end 1998, the effect on 1999 net earnings of such a decrease in exchange rates was also estimated to be an insignificant amount.
The Company's Consolidated Financial Statements and the Independent Auditors' Report thereon and the Supplementary Financial Statement Schedules listed on the accompanying Index to Financial Statements and Financial Statement Schedules are filed as part of this report.