(2) Income from continuing operations excluding realized investment gains and losses and before interest and income tax expense and dividends on Capital Securities of Delphi Funding L.L.C.
(3) In 1999, the Company disposed of Unicover and recognized an after-tax loss of $13.8 million on the disposition. After-tax income from Unicover's operations totaled $13.2 million in 1998. See Note Q to the Consolidated Financial Statements. The Company discontinued its long-term care business in 1996 and recorded a one-time after-tax charge of $5.8 million in 1996 attributable to this discontinuance. After-tax operating losses on this business were $0.8 million and $2.3 million in 1996 and 1995, respectively.
(9) Reflects the issuance of and the payment of dividends on $100.0 million of Capital Securities by Delphi Funding L.L.C. (the "Capital Securities"). See Note J to the Consolidated Financial Statements.
Premium and Fee Income. Premium and fee income in 1999 was $485.3 million as compared to $426.9 million in 1998, an increase of 14%. This increase was primarily attributable to growth in the Company's group life, disability and travel accident products within its group employee benefits segment. This growth reflects high levels of new business production and normal growth in employment and salary levels for the Company's existing customer base. Excess workers' compensation premiums for 1999 were in line with 1998 levels reflecting improvements in the pricing environment in this market sector. As of December 31, 1999, the Company has terminated its participation in substantially all of the reinsurance pools in which it had historically participated. See "Business - Reinsurance." In 1999, reinsurance pools, in the aggregate, represented $59.7 million of premium income and $57.4 million of incurred benefits. The Company does not expect its withdrawals from these reinsurance pools to have a material impact on its underwriting results. Deposits from the Company's SPDA products, including the Company's MVA annuity product, were $77.3 million in 1999 as compared to $46.0 million in 1998. Deposits for these products, which are long-term in nature, are not recorded as premiums; instead, the deposits are recorded as a liability. The increase in annuity deposits in 1999 is principally the result of an increase in the number of networks of independent agents distributing the Company's annuity products, as well as enhancements made to the Company's products to improve their competitive position in the marketplace and a more favorable environment for fixed annuity sales due to increases in interest rates during 1999.
Net Investment Income. Net investment income in 1999 was $180.9 million as compared to $168.7 million in 1998, an increase of 7%. This increase primarily reflects an increase in the weighted average annual yield on invested assets and an increase in average invested assets in 1999. The weighted average annual yield on invested assets, excluding realized and unrealized investment gains and losses, was 8.4% on average invested assets of $2,149.4 million in 1999 and 8.1% on average invested assets of $2,083.0 million in 1998.
Benefits and Expenses. Policyholder benefits and expenses were $521.2 million in 1999 as compared to $470.6 million in 1998, an increase of 11%. Benefits and expenses for the Company's group employee benefit products increased by $43.8 million in 1999 primarily due to growth in this segment. The combined ratio (loss ratio plus expense ratio) for the Company's group employee benefits segment decreased from 96.5% in 1998 to 95.2% in 1999. This decrease was primarily attributable to changes in the Company's product mix. Benefits and interest credited on asset accumulation products decreased by $2.5 million in 1999 principally due to a decrease in average funds under management from $628.7 million in 1998 to $622.9 million in 1999, partially offset by an increase in the weighted average annual crediting rate on asset accumulation products from 5.2% in 1998 to 5.3% in 1999.
Net Realized Investment (Losses) Gains. Net realized investment losses were $25.7 million in 1999 as compared to net realized investment gains of $8.1 million in 1998. The Company's investment strategy results in periodic sales of securities and the recognition of realized investment gains and losses.
Interest Expense. Interest expense was $18.2 million in 1999 as compared to $17.4 million in 1998. This increase was primarily due to an increase in average outstanding borrowings under the Credit Agreement, partially offset by a decline in the weighted average borrowing rate on the Credit Agreement and a decrease in the average principal amount of the SIG Senior Notes due to the scheduled partial principal repayment on the notes in 1999.
Income Tax Expense. The Company's effective tax rate decreased from 31.0% in 1998 to 30.6% in 1999 primarily due to a decrease in income taxed at the Company's marginal tax rate as a result of net realized investment losses in 1999 as compared to net realized investment gains in 1998.
Operating Income. Income from continuing operations excluding realized investment gains and losses and before interest and income tax expense and dividends in 1998 was $125.0 million as compared to $118.3 million in 1997, an increase of 6%. This increase is primarily attributable to the growth in the Company's group employee benefits segment and the increase in yield on invested assets in the asset accumulation products segment.
Interest Expense. Interest expense was $17.4 million in 1998 as compared to $15.0 million in 1997. This increase was primarily due to additional borrowings under the Credit Agreement in 1998 to fund acquisitions and investment opportunities.
Discontinued Operations. During 1998, income from Unicover's operations totaled $13.2 million, net of tax expense of $8.8 million. Effective April 30, 1999, the Company completed the disposition of Unicover, which was acquired in the fourth quarter of 1998.
General. The Company had approximately $286.0 million of financial resources available at the holding company level at December 31, 1999, which was primarily comprised of investments in the common stock of its investment subsidiaries and fixed maturity securities. The assets of these investment subsidiaries are primarily invested in fixed
maturity securities, balances with independent investment managers and marketable securities. Substantially all of the amounts invested with independent investment managers are withdrawable at least annually, subject to applicable notice requirements. A shelf registration is also in effect under which up to $49.2 million in securities may be issued by the Company.
Cash Flows. Operating activities increased cash and cash equivalents by $111.3 million in 1999 as compared with an increase of $19.0 million in 1998, excluding the effect of the cession of $101.5 million of policy liabilities to Oracle Re in 1998 and the recapture of $10.0 million of these liabilities in 1999 (see Note O to the Consolidated Financial Statements). Operating cash flows in 1999 include $58.1 million from a reinsurance transaction that was rescinded. These funds were returned to the ceding company in January 2000. Also contributing to the increase in operating cash flows in 1999 was a decrease in federal income taxes paid principally due to timing differences in recognizing income from investing activities. Net investing activities provided $96.6 million of cash during 1999 primarily from sales of securities, and financing activities used $159.1 million of cash principally due to a reduction in securities lending and reverse repurchase agreement liabilities.
During the year ended December 31, 1999, the Company reduced its investments in mortgage-backed securities to 21% of total invested assets or $524.5 million, from 35% of total invested assets, or $775.0 million, at December 31, 1998. Approximately 43% of the Company's mortgage-backed securities are guaranteed by U.S. Government sponsored entities as to the full amount of principal and interest and the remaining 57% consists of investments in trusts created by banks and finance and mortgage companies. Ninety-four percent of the Company's mortgage-backed securities portfolio, based on fair values, has been rated as investment grade by nationally recognized statistical rating organizations. Mortgage-backed securities subject the Company to a degree of interest rate risk, including prepayment and extension risk, which is generally a function of the sensitivity of each security's underlying collateral to prepayments under varying interest rate environments and the repayment priority of the securities in the particular securitization structure. The Company seeks to limit the extent of this risk by emphasizing the more predictable payment classes and securities with stable collateral.
The Company maintains an investment program in which securities were financed using advances from the FHLB. The Company has utilized this program to manage the duration of its liabilities and to earn spread income, which is the difference between the financing cost and the earnings from the securities purchased with those funds. At December 31, 1999, the Company had outstanding advances of $75.0 million that do not begin to mature until 2003. In addition, the Company utilizes reverse repurchase agreements, futures and option contracts and interest rate swap contracts from time to time in connection with its investment strategy. These transactions require the Company to maintain securities or cash on deposit with the applicable counterparty as collateral. As the market value of the collateral or contracts changes, the Company may be required to deposit additional collateral or be entitled to have a portion of the collateral returned to it. The Company also maintains a securities lending program under which certain securities from its portfolio are loaned to other institutions for short periods of time. The collateral received for securities loaned is recorded at the fair value of the collateral, which is generally in an amount in excess of the market value of the securities loaned. The Company monitors the market value of the securities loaned and obtains additional collateral as necessary.
Asset/Liability Management and Market Risk. Because the Company's primary assets and liabilities are financial in nature, the Company's financial position and earnings are subject to risks resulting from changes in interest rates. The Company manages this risk by active portfolio management focusing on matching the durations of invested assets and related liabilities to minimize the exposure to fluctuations in interest rates and by the adjustment of the crediting rate on annuity products. In addition, the Company, at times, utilizes exchange-traded futures and option contracts to reduce the risk associated with changes in the value of its fixed maturity portfolio due to changes in the interest rate environment and to reduce the risk associated with changes in interest rates in connection with anticipated securities purchases. Generally, market prices of fixed maturity securities decline in an environment of increasing interest rates in a manner similar to that of U.S. Treasury securities. Therefore, in order to reduce the extent of this interest rate risk, the Company enters into option contracts and short U.S. Treasury futures, the value of which will rise in such an environment. At December 31, 1999, the Company had realized gains of $13.3 million on closed positions and unrealized gains of $15.3 million on open positions related to this program that have been deferred and recorded as adjustments to the amortized cost of the fixed maturity securities being hedged.
The Company periodically analyzes the results of its asset/liability matching through cash flow analysis and duration matching under multiple interest rate scenarios. These analyses enable the Company to measure the potential gain or loss in fair value of its interest-rate sensitive financial instruments due to hypothetical changes in interest rates. Based on these analyses, if interest rates were to immediately increase by 10% from their year-end levels, the fair value of the Company's interest-sensitive assets, net of corresponding changes in the fair value of cost of business acquired and insurance and investment-related liabilities, would decline by approximately $85.7 million at December 31, 1999 as compared to a decline of approximately $69.8 million at December 31, 1998. These analyses incorporate numerous assumptions and estimates and assume no changes in the composition of the Company's investment portfolio in reaction to such interest rate changes. Consequently, the results of this analysis
A portion of the Company's trading account portfolio consists of equity securities which are subject to risks resulting from, among other things, changes in the level of equity prices. To reduce the extent of this risk, the Company has entered into corresponding short positions relating to certain of these securities. If the fair value of the Company's trading account securities were to decrease by 10% from their year-end levels, the fair value of these securities, net of the corresponding change in the fair value of the related short positions, would decrease by approximately $10.9 million at December 31, 1999 as compared to a decline of approximately $5.5 million at December 31, 1998.
The Year 2000 issue relates to whether computer systems will properly recognize date-sensitive information in years subsequent to 1999. Prior to 2000, the Company underwent a corporate-wide program to address the Year 2000 issue, as it relates to its own computer systems, as well as to instances in which computer systems of third parties may have a significant impact on the Company's operations, such as those of suppliers, business partners, customers, facilities and telecommunications. Since 1997, the Company has incurred $8.2 million of costs to address the Year 2000 issue, of which $6.1 million was expensed and $2.1 million was capitalized. The Company does not anticipate incurring any material additional costs related to the Year 2000 issue. The Company has not experienced any significant disruptions of business operations related to the Year 2000 issue to date and believes that the risk of any such disruption in the future is low, although no assurance can be given in this regard. It is possible that Year 2000 problems that are not currently apparent may arise in the future. Accordingly, the Company will continue to monitor its systems for Year 2000 compliance.
The information required by Item 8 is included in this Form 10-K beginning on page 24 of this Form 10-K.