The following discussion presents our past results and our expectations for the near term future. The supplementary financial information and the consolidated financial statements and related notes, all of which are integral parts of the following analysis of our results and our financial position, are incorporated by reference from the Corporation's 1999 Annual Report to Shareholders, pages 15, 16 and 40 through 61.
Certain statements in this document, as well as certain statements incorporated by reference herein, may be considered to be "forward looking statements" as that term is defined in the Private Securities Litigation Reform Act of 1995, such as statements that include the words or phrases "will likely result", "are expected to", "will continue", "is anticipated", "estimate", "project" or similar expressions. Such statements are subject to certain risks and uncertainties. The factors which could cause actual results to differ materially from those suggested by any such statements include, but are not limited to, those discussed or identified from time to time in the Corporation's public filings with the Securities and Exchange Commission and specifically to: risks or uncertainties associated with the Corporation's expectations with respect to premium price increases, the non-renewal of underpriced insurance accounts or business retention or profitability estimates, as well as with respect to loss reserve adequacy, its investment income or cash flow projections, or its announced real estate plans, and more generally, to: general economic conditions including changes in interest rates and the performance of the financial markets, changes in domestic and foreign laws, regulations and taxes, changes in competition and pricing environments, regional or general changes in asset valuations, the occurrence of significant natural disasters, the development of major Year 2000 or privacy liabilities, the inability to reinsure certain risks economically, the adequacy of loss reserves or currency conversion transactions, as well as general market conditions, competition, pricing and restructurings.
Property and casualty income before taxes was $626 million in 1999 compared with $685 million in 1998 and $828 million in 1997. The decrease in earnings in 1999 was due to deterioration in underwriting results caused in large part by the continued weakness in the standard commercial classes, which include multiple peril, casualty and workers' compensation, and to a lesser extent, higher catastrophe losses. The decrease in earnings in 1998 was due to a decline in underwriting results caused in large part by substantially higher catastrophe losses compared with 1997 and to a first quarter restructuring charge of $40 million before taxes. Investment income increased in both 1999 and 1998 compared with the respective prior years.
For many years, a portion of the U.S. insurance business written by the Corporation's property and casualty subsidiaries was reinsured on a quota share basis with a subsidiary of the Sun Alliance Group plc. Similarly, a subsidiary of the Corporation assumed a portion of Sun Alliance's property and casualty business on a quota share basis. As a result of the 1996 merger of Sun Alliance with Royal Insurance Holdings plc, the agreements pertaining to the exchange of reinsurance were terminated effective January 1, 1997. Consequently, during 1997, the property and casualty subsidiaries retained a greater portion of the business they wrote directly and assumed no reinsurance from Sun Alliance. There was an additional impact on net premiums written in the first quarter of 1997 due to the effect of the portfolio transfers of unearned premiums as of January 1 of that year resulting from the changes in retention.
Premium growth in personal lines was strong in both 1999 and 1998. In commercial lines, intense competition in the worldwide marketplace has made profitable premium growth difficult, particularly in the standard commercial classes. Our priorities for 1999 were to renew good business at adequate prices and not renew underperforming accounts where we could not attain price adequacy. We made steady progress in this regard during 1999, increasing rates and non-renewing underperforming business throughout the year. Further, many of our competitors also increased rates during the latter part of 1999. As a result, the pricing outlook in the standard commercial classes is considerably brighter than it was at the outset of 1999.
Substantial premium growth was achieved in 1999 and 1998 outside the United States, particularly in Europe, our largest foreign market. Excluding the business that was assumed from Sun Alliance, non-U.S. premiums grew 12% and 9% in 1999 and 1998, respectively, in original currency.
Underwriting results were unprofitable in 1999 compared with near-breakeven results in 1998 and profitable results in 1997. The combined loss and expense ratio, the common measure of underwriting profitability, was 102.8% in 1999 compared with 99.8% in 1998 and 96.9% in 1997.
During the fourth quarter of 1997, we commenced an activity value analysis process to identify and eliminate low-value activities and improve operational efficiency while redirecting resources to activities having the greatest potential to contribute to the Corporation's results. Implementation began in the first quarter of 1998 and was substantially completed by the end of that year. The cost control initiative resulted in approximately 500 job reductions in the home office and the branch network through a combination of early retirements, terminations and attrition. Other savings resulted from improved vendor management and lower consulting expenses and other operating costs.
Reported net premiums from personal insurance increased 12% in 1999 compared with a 5% increase in 1998. After adjusting 1997 reported net premiums for the effects of the termination of the reinsurance agreement with Sun Alliance, premium growth in 1998 was 10% compared with 1997. Our in-force policy count increased in 1999 by about 10% for automobile, homeowners and other personal coverages. Such growth was achieved while maintaining our disciplined approach to pricing and risk selection. Premiums outside the United States grew significantly in 1999 and 1998, although from a small base.
Our personal insurance business produced substantial underwriting profits in each of the past three years. The combined loss and expense ratio was 89.9% in 1999 compared with 85.6% in 1998 and 83.1% in 1997.
The profitability of our homeowners business each year is affected substantially by the amount of catastrophe losses we incur. Homeowners results were profitable by a similar margin in 1998 and 1997 as an unusually low frequency of non-catastrophe related losses in 1998 substantially offset an increase in catastrophe losses. Homeowners results in 1999 were less profitable than in 1998 due to an increase in both catastrophe losses and non-catastrophe losses. The frequency of non-catastrophe related losses returned to a more normal level in 1999. Results in 1999 were also adversely affected by two large losses aggregating $15 million net of reinsurance. Homeowners results were unprofitable outside the United States in each of the past three years as we are still building the critical mass necessary to absorb the costs of operating the franchise. Catastrophe losses represented 11.8 percentage points of the loss ratio for this class in 1999 compared with 8.5 percentage points in 1998 and 2.9 percentage points in 1997.
Our personal automobile business produced substantial profits in each of the last three years. Results in each year benefited from stable loss frequency and severity.
Other personal coverages, which include insurance for personal valuables and excess liability, were highly profitable in each of the past three years, as favorable loss experience has continued.
losses compared with 1997. Property results deteriorated further in 1999 due primarily to several large losses overseas. Catastrophe losses in 1999 were similar to those in 1998. Catastrophe losses represented 9.6 percentage points of the loss ratio for this class in 1999 compared with 8.6 percentage points in 1998 and 1.5 percentage points in 1997.
Results for our casualty business were unprofitable in each of the past three years. Results deteriorated in 1999, primarily in the automobile and primary liability components. In each year, but more so in 1998 and 1997, casualty results were adversely affected by incurred losses relating to asbestos and toxic waste claims. The excess liability component of our casualty coverages was modestly unprofitable in 1999 compared with the near breakeven results in 1998 and the profitable results in 1997 due to increases in the frequency of large losses as well as declining prices. Excess liability results in each of the past three years benefited from favorable development of prior year loss reserves. Results for the primary liability component were unprofitable in each of the past three years, but more so in 1999 and 1997 due to a higher frequency of large losses in those years. Results in the automobile component were increasingly unprofitable in each of the past three years due to an increase in the frequency of losses. Our commercial automobile book of business has been inadequately priced, a consequence of the prolonged soft market.
Workers' compensation results were unprofitable in each of the past three years, reflecting the cumulative effect of price reductions over the past several years. Results were also adversely affected in 1999 and 1998 by an increased frequency of large losses.
Our specialty commercial business produced substantial underwriting profits in each of the last three years. The combined loss and expense ratio was 93.6% in 1999 compared with 91.5% in 1998 and 87.5% in 1997.
Property and marine results were unprofitable in each of the past three years. The positive effect of the pricing initiatives and the culling of unprofitable accounts in 1999 was somewhat offset by higher catastrophe losses. Catastrophe losses for this class represented 10.2 percentage points of the loss ratio in 1999 compared with 5.7 percentage points in 1998 and 4.9 percentage points in 1997. Results in all three years were adversely affected by a high frequency of large property losses, including several overseas losses in 1998 and 1997.
Our financial institutions business was also profitable in each of the last three years due to favorable loss experience in the fidelity component of this business. The standard commercial business
The process of establishing loss reserves is a complex and imprecise science that reflects significant judgmental factors. This is true because claim settlements to be made in the future will be impacted by changing rates of inflation and other economic conditions, changing legislative, judicial and social environments and changes in our claim handling procedures. In many liability cases, significant periods of time, ranging up to several years or more, may elapse between the occurrence of an insured loss, the reporting of the loss and the settlement of the loss. In fact, approximately 65% of our net loss reserves at December 31, 1999 were for incurred but not reported (IBNR) losses -- claims that had not yet been reported to us, some of which were not yet known to the insured, and future development on reported claims.
Judicial decisions and legislative actions continue to broaden liability and policy definitions and to increase the severity of claim payments. As a result of this and other societal and economic
developments, the uncertainties inherent in estimating ultimate claim costs on the basis of past experience continue to further complicate the already complex loss reserving process.
In 1993, Pacific Indemnity Company, a subsidiary of the Corporation, entered into a global settlement agreement with Continental Casualty Company (a subsidiary of CNA Financial Corporation), Fibreboard Corporation, and attorneys representing claimants against Fibreboard for all future asbestos-related bodily injury claims against Fibreboard. This agreement was subject to final appellate court approval. Pursuant to the global settlement agreement, a $1.525 billion trust fund would be established to pay "future" claims, defined as claims that were not filed in court before August 27, 1993. Pacific Indemnity would contribute approximately $538 million to the trust fund and Continental Casualty would contribute the remaining amount. In December 1993, upon execution of the global settlement agreement, Pacific Indemnity and Continental Casualty paid their respective shares into an escrow account. Upon final court approval of the settlement, the amount in the escrow account, including interest earned thereon, would be transferred to the trust fund.
Pacific Indemnity and Continental Casualty reached a separate agreement in 1993 for the handling of all "pending" asbestos-related bodily injury claims, defined as claims pending on August 26, 1993 against Fibreboard. Pacific Indemnity's obligation under this agreement with respect to such pending claims was approximately $635 million, all of which was paid by the end of 1996. The agreement further provided that the total responsibility of both insurers with respect to pending and future asbestos-related bodily injury claims against Fibreboard would be shared between Pacific Indemnity and Continental Casualty on an approximate 35% and 65% basis, respectively.
The trilateral agreement reaffirmed portions of an agreement reached in March 1992 between Pacific Indemnity and Fibreboard. Among other matters, that 1992 agreement eliminated any Pacific Indemnity liability to Fibreboard for asbestos-related property damage claims.
The trilateral agreement was never appealed to the United States Supreme Court and is final. Upon final disapproval of the global settlement agreement, the trilateral agreement became effective.
We continue to have potentially significant asbestos exposure, primarily on those traditional defendants who manufactured, distributed or installed asbestos products for whom we wrote excess liability coverages. Such exposure has increased in recent years due to the erosion of much of the underlying limits and the non-viability of other defendants.
Our other potential asbestos exposures are mostly peripheral defendants, including a mix of manufacturers and distributors of certain products that contain asbestos as well as premises owners. Generally, these insureds are named defendants on a regional rather than a nationwide basis. As the resources of traditional asbestos defendants have been depleted, more peripheral parties have been drawn into litigation. Thus, we continue to receive notices of new asbestos claims and new exposures on existing claims despite the fact that practically all manufacturing and usage of asbestos ended nearly two decades ago.
Uncertainties also remain as to the Superfund law itself. Superfund's taxing authority expired on December 31, 1995. Notwithstanding continued pressure by the insurance industry and other interested parties to achieve a legislative solution that would reform the liability provisions of the law, Congress has not yet addressed the issue. It is currently not possible to predict the direction that any reforms may take, when they may occur or the effect that any changes may have on the insurance industry.
Litigation costs remain substantial, particularly for hazardous waste claims. A substantial portion of the funds we have expended to date has been for legal fees incurred in the prolonged litigation of coverage issues. Primary policies provide a limit on indemnity payments but many do not limit defense
Reserves for asbestos and toxic waste claims cannot be estimated with traditional loss reserving techniques that rely on historical accident year loss development factors. We have established case reserves and expense reserves for costs of related litigation where sufficient information has been developed to indicate the involvement of a specific insurance policy. In addition, IBNR reserves have been established to cover additional exposures on both known and unasserted claims. These reserves are continually reviewed and updated. We have evaluated ultimate incurred losses using newly emerging techniques for estimating environmental liabilities and have expanded our claim data base. As a result, we are somewhat more confident about the range of likely ultimate incurred losses relating to asbestos and toxic waste claims. Therefore, the incurred losses relating to asbestos and toxic waste claims were only $47 million in 1999 and $68 million in 1998, substantially less than the $125 million in 1997. Further increases in such loss reserves in 2000 and future years are possible as legal and factual issues concerning these claims continue to be clarified. The amount cannot be reasonably estimated.
investment income, have provided more than sufficient funds to pay losses, operating expenses and dividends to the Corporation.
Corporate and other includes investment income earned on corporate invested assets, interest and other expenses not allocable to the operating subsidiaries, and the results of our real estate subsidiary. Corporate and other produced a loss before taxes of $4 million in 1999 compared with income of $23 million in 1998 and $41 million in 1997. The decrease in corporate and other income in 1998 and again in 1999 was due primarily to increasingly higher interest expense in each year.
We own approximately $355 million of land which we expect will be developed in the future. In addition, we own approximately $190 million of commercial properties and land parcels under lease. We are continuing to explore the sale of certain of our remaining properties.
Loans receivable, which were issued in connection with our joint venture activities and other property sales, are primarily purchase money mortgages. Such loans, which amounted to $81 million at December 31, 1999, are generally collateralized by buildings and, in some cases, land. We continually evaluate the ultimate collectibility of such loans and establish appropriate reserves.
Net investment gains realized by the Corporation and its property and casualty subsidiaries were as follows:
Decisions to sell securities are governed principally by considerations of investment opportunities and tax consequences. Thus, realized investment gains and losses may vary significantly from year to year.
The unrealized appreciation or depreciation of investments carried at market value, which includes equity securities and fixed maturities classified as available-for-sale, is reflected in a separate component of other comprehensive income, net of applicable deferred income tax.
The unrealized market appreciation before tax of those fixed maturities carried at amortized cost was $59 million, $138 million and $147 million at December 31, 1999, 1998 and 1997, respectively. Such unrealized appreciation was not reflected in the consolidated financial statements.
The table on the following page provides information about our fixed maturity investments, which are sensitive to changes in interest rates. The table presents cash flows of principal amounts and related weighted average interest rates by expected maturity dates at December 31, 1999 and 1998. The cash flows are based on the earlier of the call date or the maturity date or, for mortgage-backed securities, expected payment patterns. Actual cash flows could differ from the expected amounts.
Prepayment risk refers to the changes in prepayment patterns related to decreases and increases in interest rates that can either shorten or lengthen the expected timing of the principal repayments and thus the average life and the effective yield of a security. Such risk exists primarily within our
portfolio of mortgage-backed securities. We monitor such risk regularly and invest primarily in those classes of mortgage-backed securities that are less subject to prepayment risk.
Mortgage-backed securities comprised 33% and 40% of our taxable bond portfolio at year-end 1999 and 1998, respectively. About 35% of our mortgage-backed securities holdings at December 31, 1999 related to residential mortgages consisting of government agency pass-through securities, government agency collateralized mortgage obligations (CMOs) and AAA rated non-agency CMOs backed by government agency collateral or single family home mortgages. The majority of the CMOs are actively traded in liquid markets and market value information is readily available from broker/dealers. An additional 40% of our mortgage-backed securities were call protected AAA rated commercial securities. The remaining mortgage-backed holdings were all in investment grade commercial mortgage-backed securities.
market prices of the equity securities held at December 31, 1999 and 1998 would have resulted in a decrease of $77 million and $109 million, respectively, in the fair value of the equity securities portfolio.
All of the above risks are monitored on an ongoing basis. A combination of in-house systems and proprietary models and externally licensed software are used to analyze individual securities as well as each portfolio. These tools provide the portfolio managers with information to assist them in the evaluation of the market risks of the portfolio.
The Year 2000 team included employees of the Corporation and software consultants. A portion of the remediation effort was accomplished by redirecting existing systems resources to the Year 2000 effort. However, we do not believe that this had a significant adverse effect on other systems initiatives.
The cost to address the Year 2000 IT systems issue, including compensation of employees and the cost of consultants, approximated $36 million. Approximately $6 million, $14 million and $9 million was incurred in 1999, 1998 and 1997, respectively. These amounts do not include the cost of computer equipment purchased to replace equipment that would have been upgraded in the normal course of business, but not necessarily prior to January 2000. Future expenditures related to the Year 2000 issue are expected to be negligible.
We have closely monitored the potential impact of the Year 2000 issue on insurance coverages written by our property and casualty subsidiaries. To date, we have received a relatively small number of claims related to the Year 2000 issue. The policies under which such claims have been made include provisions that we believe either preclude or limit the amount of coverage. For these reasons, management does not believe at this time that there is a likelihood of a significant adverse financial impact from Year 2000 related losses. Nevertheless, it is possible that Year 2000 related losses may emerge that would adversely affect operating results in future periods.
In February 1994, the Board of Directors authorized the repurchase of up to 10,000,000 shares of common stock. Through March 1997, the Corporation had repurchased 6,851,600 shares under the 1994
share repurchase authorization. In March 1997, the Board of Directors replaced the 1994 authorization with a new authorization to repurchase up to 17,500,000 shares of common stock. In July 1998, the Board of Directors authorized the repurchase of up to an additional 12,500,000 shares. Through December 31, 1999, the Corporation had repurchased 20,591,600 shares under the 1997 and 1998 authorizations. As of December 31, 1999, 9,408,400 shares remained under the current share repurchase authorizations. In the aggregate, the Corporation repurchased 2,596,700 shares in open-market transactions in 1999 at a cost of $145 million, 8,203,000 shares in 1998 at a cost of $609 million and 12,940,500 shares in 1997 at a cost of $828 million.
The Corporation filed a shelf registration statement which the Securities and Exchange Commission declared effective in September 1998, under which up to $600 million of various types of securities may be issued by the Corporation or Chubb Capital Corporation, a wholly owned subsidiary. No securities have been issued under this registration statement.
The Corporation has two credit agreements with a group of banks that provide for unsecured borrowings of up to $500 million in the aggregate. The $200 million short term revolving credit facility, which was to have terminated on July 7, 1999, was extended to July 5, 2000, and may be renewed or replaced. The $300 million medium term revolving credit facility terminates on July 11, 2002. On the respective termination dates, any loans then outstanding become payable. There have been no borrowings under these agreements. These facilities are available for general corporate purposes and to support Chubb Capital's commercial paper borrowing arrangement.
In 1999, the Corporation adopted Statement of Position (SOP) 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, which was issued by the American Institute of Certified Public Accountants. This SOP requires that certain costs incurred to develop or obtain computer software for internal use should be capitalized and amortized over the software's expected useful life. Prior to 1999, we expensed all development costs of internal use computer software. The SOP has been applied prospectively. The adoption of SOP 98-1 increased the Corporation's net income in 1999 by $17 million. The effect on net income will decrease in future years as the new method of accounting is phased in.