The following summary sets forth selected financial data with respect to AIG for the five fiscal years ended December 31, 1999. The balance sheet and income statement data have been derived from AIG's consolidated financial statements which have been audited, for fiscal years through 1998 by Johnson Lambert & Co., AIIG's independent auditors and, for fiscal year 1999 by Deloitte & Touche, AIG's independent auditors. The data set forth below should be read in conjunction with the audited financial statements and notes thereto included elsewhere herein.
The transfer of operations of AIIG to AIG has been accounted for at historic cost in a manner similar to that in pooling-of-interests accounting.
Premiums earned increased by 8.2% in 1999 to $6,388,323 from $5,901,939 in 1998. Premiums earned for 1998 decreased by 4.4% from $6,172,610 reported in 1997. In 1999, 1998, and 1997 premiums earned includes $182,959, $131,250 and $720,298, 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 1999 increased by 5.8% as compared to 1998. 1998 premiums earned increased by 3.6% as compared to 1997.
The increase in earned premiums during 1999 is attributable to continued growth of the AICPA Plan. This growth is primarily the result of an increase in the number of insureds under the AICPA Plan and from certain rate increases associated with a "step plan" which was initiated during 1995 and the maturing of claims-made coverage. Under the step plan, insureds are offered discounted premium rates for favorable loss experience. However, as these insureds experience losses their premiums are "stepped up" accordingly. Because of the use of claims-made policies, as the number of years of coverage provided increases, CNA's (and AIG's) exposure increases. This additional exposure results in an increase in premiums charged.
Unrealized gain on investments is $154,059 at December 31, 1999 as compared to $1,156,993, net of tax at December 31, 1998. AIG 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.
Losses and loss adjustment expenses incurred increased by 40.5% to $6,744,893 in 1999 from $4,797,657 in 1998. Losses and loss adjustment expense for 1998 increased by 1.0% from $4,748,833 in 1997. These amounts include favorable development of prior years' estimates of losses and loss adjustment expense of approximately $2,533,000 in 1999, $4,883,000 in 1998 and $1,411,000 in 1997. As adjustments to prior estimates of losses and loss adjustment expenses become known, such adjustments are included in current operations. AIG's loss ratio, calculated as the ratio of losses and loss adjustment expense to premiums earned, is 105.6% in 1999, 81.3% in 1998 and 76.9% in 1997. The ratio calculated using only losses and loss adjustment expenses incurred for the current year (excluding the effects of favorable development and excluding reductions to retrocession premiums) is 149.5% in 1999, 167.8% in 1998, 112.9% in 1997.
Favorable development on prior year losses is attributable to various economic trends and factors. In a strong economic environment, fewer professional liability claims are likely to occur since fewer companies are experiencing the kind of financial stress or failure that can often lead to such claims. However, AIG has noted that under the CNA program, loss frequency has increased in recent years while loss severity has remained constant. This increase in loss frequency can be attributed to CNA's implementation of a step plan (also see above discussion of premiums) in 1995 that was designed to attract a large number of new insureds, predominantly smaller firms, to the program. CNA expected loss severity to decrease and offset the effects of increases in loss frequency, but to date this decrease has not occurred. Accordingly, losses have trended upward in the most recent years. Additionally, in recent years, many of the CNA insureds have opted to purchase defense coverage outside of policy limits which results in larger reserve requirements.
Operating and management expenses increased by 70.6% in 1999 to $1,097,171 from $642,925 in 1998. 1998 operating and management expenses increased by 3.7% from $619,694 in 1997. The increase in 1999 is due to the write-off of all expenses relating to the redomestication.
The effective tax rate was 16.0% in 1998 and 18.7% in 1997. These rates differ from the statutory federal rate primarily due to the effects of tax- exempt municipal bond income. Effective December 2, 1999, the date of redomestication to Bermuda, the Company ceased to pay corporate income taxes, which meant the Company's deferred tax asset could not be utilized. As the Company reported a tax loss for the period ended December 2, 1999, a tax benefit was received. The current year tax charge of $676,317 comprises a deferred tax write off of $1,248,693 and a current year tax benefit of $572,376.
As of December 31, 1999, total invested assets amounted to $39,281,257, a decrease of $3,267,401 or 7.6% from $42,548,658 at December 31, 1998. Cash balances increased from $1,450,795 at December 31, 1998 to $5,127,555 at December 31, 1999. The amount of cash and cash equivalents varies depending on the maturities of fixed term investments and on the level of funds invested in money market mutual funds. The ratio of cash and invested assets to total liabilities and stockholders' equity at December 31, 1999 was .94 to 1, compared to a ratio of .91 to 1 at December 31, 1998.
AIG's gross premiums assumed in 1999 amounted to $5,847,122, a decrease of $530,103 from 1998. Gross premium assumed in 1998 increased by $580,149, or 10% from 1997. Assumed reinsurance premiums receivable represents current assumed premiums receivable less commissions payable to the fronting carriers. This balance was $1,192,727 at December 31, 1998. As of December 31, 1999, this balance is presented on a net basis with reinsurance balances payable and therefore no comparable balance exists as of that date. 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.
Reinsurance recoveries represent AIG's estimate of losses to be reimbursed by its reinsurer from future loss payments. AIG (through AIC) entered into excess of loss retrocession agreements to limit its retained risk on any one claim underwritten by Coregis Group, Inc. (formerly Crum and Forster Managers Corporation), to $50,000 in 1989 and 1990 and $62,500 in 1991 through mid-1993, subject to specified maximum recoveries for each contract year. Retrocession premiums ceded by AIG are adjustable within a specified range based on actual experience under each contract. Amounts recoverable from the reinsurers pursuant to retrocession agreements have been estimated using actuarial assumptions consistent with those used in establishing the liability for unpaid losses and loss adjustment expenses. The actuary suggested a decrease in its analysis as of December 31, 1999 which is reflected in the decrease to reinsurance recoveries receivable from $875,685 at December 31, 1998 to $674,223 at December 31, 1999, a $201,462, or 23.0%.
Prepaid expenses and other assets amounted to $80,587 at December 31, 1999, a decrease of 75.3% from 1998.
Deferred policy acquisition costs, representing the deferral of ceding commission expense related to premiums not yet earned, decreased from December 31, 1998 along with the increase in unearned premiums. The current ceding commission rate, which became effective August 1, 1995, is 28.5%.
The Company paid its eighteenth consecutive quarterly dividend of $0.65 per share during the fourth quarter of 1999.
During 1999, 1998 and 1997, the Board of Directors declared quarterly dividends of $0.65 per share totaling $863,289, $865,587 and $867,735, 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 expansion.
The above table presents the development of balance sheet liabilities for 1988 through 1999 as of year-end 1999. 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.
The "cumulative redundancy (deficiency)" represents the aggregate change in the estimates over all prior years. For example, the 1994 liability has developed a $12,190,000 redundancy which has been reflected in income in subsequent years as the reserves were reestimated.
AIG was aware of the issues associated with the programming code in existing computer systems as the year 2000 approached. The "Year 2000" problem was due to computer programs being written using two digits rather than four to define the applicable year. Programs with 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.
The Company's operations are conducted through its management company, USA Offshore Management, Ltd. ("USAOM"). Prior to the redomestication of the Company, Vermont Insurance Management, Inc. ("VIM") provided these services.
On December 2, 1999, the Company and its predecessor entity, AIIG, consummated an exchange transaction pursuant to an Exchange Agreement, in which AIIG transferred all of its assets and liabilities to the Company in exchange for newly issued common shares of the Company. See Note 2 to the Consolidated Financial Statements for a further description of the transaction.
Schedules I, II, III, V, and VI are omitted as they are inapplicable, immaterial, or because the required information may be found in the audited consolidated financial statements and notes thereto.