The Company continues to focus its emphasis on its crop segment which has recorded operating profits during each of the last six years. The principal lines of the Company's Crop Insurance segment are MPCI, supplemental coverages, and named peril insurance. MPCI is a federally subsidized risk management program designed to encourage farmers to manage their risk through the purchase of insurance policies. MPCI provides farmers with yield coverage for crop damage from substantially all natural perils. CRC is an extension of the MPCI program which provides farmers with protection from revenue loss caused by changes in crop prices, low yields or both. As used herein, the term MPCI includes CRC, unless the context indicates otherwise. For the year ended December 31, 1999, the Company had a market share of approximately 16% of MPCI business written in the United States.
The Company's results are significantly impacted by its crop business, particularly its MPCI line. Results from the crop lines are not generally known until the fourth quarter of the year, after crops are harvested and final market prices are established. Crop segment results are particularly dependent on events beyond the Company's control, notably weather conditions during the crop growing seasons in the states where the Company writes a substantial amount of its crop insurance, the market price of grains on various commodity exchanges and overall worldwide supply and demand, the continuing globalization of the crop industry and its effect on the export of crops to other countries and the volatility of crop prices resulting from domestic and foreign policy decisions. Additionally, federal regulations governing aspects of crop insurance are frequently modified, and any such changes may impact crop insurance results.
Results of Operations Year ended December 31, 1999 Compared to Year ended December 31, 1998
California construction defect claims increased as a result of the 1995 California Supreme Court decision in Montrose Chemical Corporation vs. Admiral Insurance Company. In that decision, the Court adopted the "continuous trigger" theory of insurance coverage for third party cases involving claims of continuous, progressive or deteriorating bodily injury or property damage. Under this theory, the timing of the insured's act which allegedly caused the accident, event or condition resulting in a claim is largely immaterial. As long as the potential damages remain outstanding, all of the contractor's or subcontractor's successive policies potentially may provide coverage. Thus, the Court's Montrose decision created a whole new basis for coverage under years of previously issued policies. Beginning in 1996, the Company altered its underwriting criteria for construction risks and began endorsing policies exposed to these types of continuous exposures in order to avoid coverage for conditions which existed prior to the inception of Company policies. Primarily as a result of the unexpected increase in claims from the 1990 through 1995 accident years, the Company increased its loss reserves during 1999 for 1998 and prior years by approximately $44.0 million.
The Company experienced increased demand for its crop segment products during 1999 as compared to 1998, particularly products sold under the federally subsidized Multi-Peril Crop Insurance (MPCI) program and the Company's proprietary CRCPlus product. During 1999, the Company's MPCI premiums increased to approximately $365 million from $274 million in 1998. The Company's preliminary estimate of the MPCI premium for 2000 is $392 million based on field reports and early applications. The actual amount of MPCI premium will not be known until final acreage reports are received in the third quarter. Accordingly, the actual amount of MPCI premium for 2000 may vary substantially from the preliminary estimate. In 1999 the Company's net expenses as a percentage of written premiums increased from 1998 to 1999 due to a decrease in the rate at which the Company is reimbursed by the federal government for the expenses of operating its MPCI program. In 1998 the Company's reimbursement rate was approximately 24.7%, while in 1999 this reimbursement rate fell to 21.6%. Due to competitive pressures, the Company was unable to pass any of this expense reduction along to its agents as agents' commissions remained relatively constant. The Company does not expect a similar reduction in its expense reimbursements from the federal government during the 2000 crop year, but a change in the Company's mix of business could result in a reduction in its total reimbursement rate for the 2000 crop season.
The increased demand for the Company's proprietary CRCPlus product in 1999 exceeded the Company's traditional reinsurance program. Five factors generally contributed to this demand: steadily declining commodity prices during the primary sales season, increased federal subsidies for purchasers of crop insurance, rapid market acceptance of this product for newly offered specialty crops, a technical error in the quoting software for one specialty crop which understated the applicable premium for that crop, and disproportionately high coverage levels for certain crops. As a result, the Company elected to close its sales season early and limit available coverage for some crops. The Company experienced additional costs in 1999 of $1.5 million in the placement of its quota share reinsurance program for CRCPlus. The Company also experienced higher operating expenses associated with the early sales closing for it CRCPlus product. These expenses totaled $5.4 million for 1999.
During 1998, as in 1997, the Company's goal in its Property and Casualty segment was to improve underwriting results through an emphasis on profitable lines, modification of marginal lines, and a discontinuation of unprofitable lines. By the fourth quarter of 1998, it became clear that this process was not meeting the Company's goals for underwriting profitability, and therefore, the Company undertook substantial restructuring of its property and casualty operations in order to focus on profitable lines of specialty business generated by its general agents and program managers. This restructuring eliminated approximately $151.0 million in annual gross written premiums from lines of business the Company believed had developed into commodity insurance products no longer meeting the criteria of its core specialty business. As part of the property and casualty operations restructuring, the Company entered into discussions for sale of some discontinued business, most notably the nonstandard automobile business, and entered into reinsurance agreements transferring the runoff of the remaining discontinued lines to reinsurers. The Company also strengthened its loss and loss adjustment reserves primarily due to continued unexpected development, principally on the discontinued lines of business. As part of the restructuring plan, the Company recorded an after tax charge in the fourth quarter of 1998 of approximately $23.3 million. Before the charges associated with the restructuring, the Company's net income for 1998 was $28.8 million. In addition to the nonstandard automobile business, the Company discontinued several product lines including coverages for certain specialty automobile lines, aviation, and complex general liability risks.
The Company's losses and loss adjustment expenses incurred increased from $213.5 million during 1997 to $237.1 million in 1998. This increase in losses and loss adjustment expenses was principally attributable to the $24.2 million strengthening in loss reserves for prior periods. Excluding the strengthening of loss reserves for prior periods, losses and loss adjustment expenses incurred decreased .3%, and the ratio of the Company's losses and loss adjustment expenses to net premiums earned increased from 63.7% in 1997 to 64.9%, excluding reserve strengthening for prior periods, in 1998. Including the reserve adjustment for prior periods, the Company's ratio of losses and loss adjustment expenses to net premiums earned in 1998 was 72.3%. In the Company's property and casualty operations, results from operations which will continue after the restructuring were considerably better than those of the operations discontinued in the restructuring. Those operations being discontinued experienced a ratio of loss and loss adjustment expense to net premiums earned of 112.0% during 1998 whereas those operations which continue after the restructuring experienced a ratio of losses and loss adjustment expenses to net premiums earned of 65.6% during 1998.
Underwriting expenses increased from $97.1 million during 1997 to $104.7 million during 1998, thus increasing the ratio of underwriting expenses to net premiums earned from 29.0% in 1997 to 31.9% in 1998. Underwriting expense in the Company's crop insurance operations increased from 1997 expenses of $9.0 million to underwriting expenses in 1998 of $14.8 million. This increase of $5.7 million resulted from a decrease in the expense reimbursement from the federal government in the Company's MPCI crop insurance program of $5.2 million, an increase in commissions paid to agents on MPCI policies purchased at the catastrophic level of $3.3 million as the market changed its commission practices on this type of policy from a flat fee to a percentage of imputed premiums, and, offsetting these increase in expenses, a decrease in the Crop Insurance segment's operating expenses of $2.8 million resulting from improvements in operating efficiencies. The Company's underwriting expenses in its Property and Casualty segment increased more modestly from $88.1 million or 32.0% of net premiums earned in 1997 to $90.0 million or 33.7% of net premiums earned in 1998. This increase in underwriting expenses in the Property and Casualty segment occurred principally from a shifting emphasis on casualty lines of business under which the Company pays a lower rate of commission to property lines of business in which the Company's acquisition expenses are greater, but where its historical loss ratios are lower.
The Company's net income was also negatively impacted by an increase in the Company's interest expense of 36.9% from $6.6 million during the year ended December 31, 1997 to $9.0 million during the year ended December 31, 1998. The increase in interest expense was a result of both an increase in the Company's average outstanding borrowings from $81.6 million during the twelve months ended December 31, 1997 to $100.0 million for the twelve months ended December 31, 1998, and an increase in the average interest rate from 8.1% during 1997 to 9.0% during 1998. The increased borrowings were used to add statutory surplus to the insurance Company's subsidiaries as well as to repurchase shares of the Company's stock under the Company's Stock Repurchase Program approved by the Board of Directors in May, 1998. During the remainder of 1998, the Company repurchased one million shares of the Company's stock at a cost of approximately $22.1 million. The Company funded these repurchases using available cash and $15 million of borrowings under its revolving credit facility. The increase in the Company's average interest rate resulted from the issuance of $94.875 million in trust preferred securities and the retirement of the Company's outstanding bank debt during the third quarter of 1997.
As an insurance holding company, the Company's assets consist primarily of the capital stock of its subsidiaries, surplus notes issued by two of its insurance company subsidiaries and investments held at the holding company level. The Company's primary sources of liquidity are receipts from interest payments on the surplus notes, payments from the profit sharing agreement with American Agrisurance, the Company's wholly owned subsidiary which operates as the general agent for the Company's crop insurance programs, tax sharing payments from its subsidiaries, investment income from, and proceeds from the sale of, holding company investments, and dividends and other distributions from subsidiaries of the Company. The Company's liquidity needs are primarily to service debt, pay operating expenses and taxes, make investments in subsidiaries, and repurchase shares of the Company's stock.
Dividends from the Insurance Companies are regulated by the regulatory authorities of the states in which each subsidiary is domiciled. The laws of such states generally restrict dividends from insurance companies to parent companies to certain statutorily approved limits. In 2000, the statutory limitation on dividends from the Insurance Companies to the Company without further insurance departmental approval is approximately $7.4 million. If the proposed transactions related to the proposed sale of Redland are completed, the Company expects that the statutory limitation on dividends from the Insurance Companies to the Company without further insurance department approval will increase to approximately $21.8 million for the remainder of 2000. This anticipated increase would result from the additional dividends that are expected to be available from American Growers if these proposed transactions are completed. See "Business-Regulation."
As of December 31, 1999, the Company maintains a credit facility (the "Credit Facility") with its bank lenders in the amount of $31.4 million, pursuant to a revised credit agreement (the "Credit Agreement") that the Company entered into with Comerica Bank as the new agent bank and U.S. Bank and First National Bank of Omaha as participating banks. The Credit Facility provides for a $31.4 million line of credit, on a fully collateralized basis. The entire amount of the line of credit was used for the issuance of an outstanding letter of credit relating to reinsurance coverage on certain crop insurance products. The Credit Facility contains covenants that do not permit the payment of dividends by the Company, requires the Company to maintain certain operating and debt service coverage ratios, requires maintenance of specific levels of surplus and requires the Company to meet certain tests established by the regulatory authorities.
The Company is currently negotiating a new credit facility with Comerica Bank, as agent bank, to replace the existing credit agreement. The Company expects that the amount of the new credit facility will be the same as the existing credit agreement and will be used for the same purpose as the existing credit agreement. Therefore, no new borrowings are expected to be available under the new credit facility. Although a definitive agreement has not been reached, the Company expects that the new credit facility will not require the Company to pledge the stock of Redland and Acceptance nor restrict the payment of dividends. Also, the Company does not anticipate that the new credit facility will contain financial maintenance covenants similar to the existing credit agreement. The Company anticipates that the new credit facility will be entered into on or before March 31, 2000.
Cash flows from the Company's crop business differs in certain respects from cash flows associated with more traditional property and casualty lines. MPCI premiums are not received from farmers until the covered crops are harvested, and when received are remitted within approximately 30 days of receipt by the Company in full to the government. Covered losses are paid by the Company during the growing season as incurred, with such expenditures reimbursed by the government within three business days. Policy acquisition and administration expenses are paid by the Company as incurred during the year. The Company periodically throughout the year receives a payment in reimbursement of its policy acquisition and administration expenses.
The Company's stockholders' equity decreased by approximately $55.2 million at December 31, 1999 as compared to December 31, 1998. The principal components of this decrease were a net loss of $36.0 million during 1999 and a decrease in the value of the Company's investment portfolio causing the unrealized gain on available-for-sale securities, net of tax, to decrease from $5.3 million at December 31, 1998 to a $12.6 million unrealized loss at December 31, 1999. This change in the unrealized gain on available-for-sale securities was attributable to a decline in the unrealized gain in the Company's fixed maturity and equity securities.
Cash used by operating activities was $20.9 million for the year ended December 31, 1999 compared to cash provided from operations for the same period in 1998 of $34.0 million. This decrease in cash flow from period to period was a result of profit sharing payments received from the federal government under the Company's MPCI crop insurance program of $57.0 million in 1998 compared to $51.5 million in 1999, $19.3 million in payments made during 1999 related to reinsurance on the Company's discontinued lines of business, and declining premium volume in the Company's Property and Casualty segment.
At December 31, 1999, the Company had $259.3 million of fixed maturity investments and mortgage loans and $25.1 million of marketable equity securities that were subject to market risk. The Company's investment strategy is to manage the duration of the portfolio relative to the duration of the liabilities while managing interest rate risk. In addition, the Company has the ability to hold its fixed maturity investments until maturity and therefore would not expect to realize a material adverse impact on income or cash flows.
The Year 2000 issue is the result of computer programs and microcontrollers which recognize only two digits rather than four to identify the year. Any computer program or microcontroller that has a date sensitive function might have recognized a date of "00" as the year 1900 rather than the year 2000. If not corrected, this could cause computers and other devices dependent upon microcontrollers to fail or perform miscalculations.
Class Action Suits The Company is a defendant in three class-action lawsuits. One case was filed in August 1999 in the Arkansas United States District Court where the plaintiffs assert the Company made false representations and engaged in deceptive trade practices related to the Company's 1999 CropRevenue CoveragePlus(R) coverage for rice. The plaintiffs seek compensatory damages, interest, attorney fees and all appropriate damages or relief. The District Court denied plaintiffs' request for class action status on March 10, 2000.
In December 1999, the Company was sued in the Nebraska United States District Court where the plaintiffs allege the Company knowingly and intentionally understated the Company's liabilities in order to maintain the market price of the Company's common stock at artificially high levels and made untrue statements of material fact. The plaintiffs seek compensatory damages, interest, costs and attorney fees. In February 2000, the Company was sued in the Nebraska United States District Court where the plaintiffs allege the Company intentionally understated the Company's liabilities in order to maintain the market price of the Company's Redeemable Preferred Securities at artificially high levels and made untrue statements of material fact. The plaintiffs seek money damages, costs and attorney fees. As of March 1, 2000 the Company noted published reports of two additional suits which may include allegations substantially similar to the allegations in the two suits now pending in the Nebraska United States District Court.
While the Company believes each of these actions are without merit, the ultimate outcome of this litigation cannot be predicted at this time and the Company currently is unable to determine the potential effect on the Company's financial position, results of operations or cash flows. The Company intends to vigorously contest the pending lawsuits and all similar suits.