The Company leases office space at 35 locations in 17 states at an aggregate monthly rental of approximately $411,700.
The following selected financial data are derived from the Company's consolidated financial statements and should be read in conjunction with the consolidated financial statements, related notes, and other financial information included elsewhere in this Annual Report.
(2) In June and December 1997, the Company acquired Lyndon and Western, respectively.
Net premiums earned for the Health Care Division decreased 19% from $197 million in 1998 to $160 million in 1999. Beginning in 1998, the Company began taking various actions to improve the results of its medical malpractice business. Such actions included exiting certain classes, terminating agents, increasing rates, and implementing more stringent underwriting guidelines for both new and renewal business. These actions contributed to an approximate $23 million decrease in earned premiums in 1999 when compared to 1998. The remaining decrease of approximately $14 million in the Health Care Division was primarily attributable to lower retention of premiums under a new reinsurance contract and competitive pricing conditions in the health and human services sector of the market.
The increase in net premiums earned for the Specialty Programs Division was primarily attributable to the Company's focus on certain specialty sectors of the commercial auto market since 1998. Most notably the company began a short term auto rental program in early 1999 that generated approximately $20 million in net premiums earned. A variety of smaller commercial auto related programs introduced in late 1998 generated an additional increase of $11 million of net premiums earned in 1999. In addition, a California workers' compensation program was introduced in 1999 which generated approximately $10 million of net premiums earned for the year. The remaining $16 million increase in net premiums earned was attributable to growth in a number of smaller programs including a summer camp program, an ice cream vendor program, a municipality program, and a New York mercantile program, none of which were individually significant.
Loss and LAE as a percentage of net earned premiums increased from 89.8% in 1998 to 94.5% in 1999. The primary reason for such increase related to certain performance and payment bonds written in 1999 for three entertainment events that did not occur which resulted in losses of approximately 38.5 million. Additionally, during 1999 the Company incurred approximately $4 million of storm losses related for Hurricane Floyd. (See Note H of the Consolidated Financial Statements).
Amortization of policy acquisition costs represented 25.1% of net premiums earned during 1999 compared to 23.1% for 1998. This increase was due primarily to higher acquisition costs related to increased writings in the Surety and Environmental, Excess and Surplus Lines Divisions partially offset by the effects of lower acquisition costs due to direct writings through several purchased agencies in late 1998 and 1999. Also during 1999, the Company recognized approximately $2.2 million less of negative goodwill amortization related to the acquisition of Lyndon as compared to 1998 and incurred costs relative to the Clarendon cut-through and other reinsurance arrangements of approximately $6.1 million. Partially offsetting these increases were premium tax refunds claimed by the Company for years 1998 and prior totaling approximately $3.6 million.
Underwriting and other expenses increased as a percentage of net premiums earned from 19.5% in 1998 to 21.9% in 1999 due to a variety of factors, including increased personnel count, an impairment charge related to intangible assets, a reallocation of certain corporate overhead expenses, an increase in the provision for doubtful accounts, and technological initiatives.
During 1999, the Company incurred approximately $5.7 million in expenses in connection with several technological and e-commerce initiatives.
The 34% increase in net premiums earned during 1998 compared to 1997 was primarily attributable to the acquisition of several new subsidiaries, including the purchase of Lyndon in May 1997, Acceleration in January 1998, and Western Indemnity and Environmental Commercial Insurance Agency, Inc. ("ECI") in December 1997. In addition, business has increased in some of the Company's core programs in the Surety and Specialty Programs Divisions as a result of geographical expansion.
Net premiums earned for the Health Care Division increased 18% from $167 million in 1997 to $197 million in 1998. Psychiatry and counseling programs showed an increase of approximately $12 million in 1998 compared to 1997 mainly due to a new business relationship with the American Professional Agency which began in late 1997. In addition, the Company purchased Western Indemnity in December of 1997 which generated an increase in net premiums earned of $23 million. Net earned premiums for dental and daycare programs increased approximately $1 million and $11 million, respectively, as a result of geographic expansion. These increases were slightly offset by the Company's planned decrease in writings for less profitable classes, mainly physicians, including the sale of the Company's Florida physicians business in December of 1997.
permit, and landfill programs and was partially offset by a decline in contract bond business for small contractors amounting to approximately $4 million.
Net premiums earned for the Alternative Risk Division were relatively flat in 1998 compared to 1997. This was primarily due to the discontinuance of an earthquake program in 1998, which resulted in an approximate $2 million decrease in earned premium offset by modest growth in several smaller programs.
The increase in net premiums earned for the Environmental, Excess and Surplus Lines Division was primarily attributable to growth in the environmental and pollution liability program. Net premiums earned for the program increased approximately $15 million from 1997 to 1998 due to the acquisition of the ECI Agency. In addition, the California contractors liability program showed an increase of $1 million from 1997 to 1998. The remaining increase was due to organic growth in existing programs.
The increase in net earned premium for the Personal and Credit Related Division was primarily attributable to the acquisition of Lyndon in May 1997 and Acceleration in January 1998, generating approximately $62 million in additional net premiums earned in 1998 when compared to 1997.
Net investment income before realized capital gains and losses increased 31% due principally to increased cash flow from operations and the contribution to net investment income from the acquisitions made in 1997, partially offset by the interest charge on funds held by the Company for the benefit of the reinsurer of the Company's aggregate excess of loss reinsurance contract.
During the fourth quarter of 1998, the Company completed an in-depth analysis of its loss and LAE reserves. As a result, the Company increased its reserves for unpaid losses and LAE by approximately $155 million. The analysis indicated significant deficiencies in loss and LAE in the Company's medical malpractice, general liability and surety lines of business. The increase in the medical malpractice loss and LAE reserves was primarily due to poor results in business written for individual physicians in various is states, most notably Ohio, Illinois, Texas and Michigan. The increase in general liability and surety reserves was due to unfavorable development in LAE reserves. For additional disclosure regarding this reserve charge and loss and LAE reserves refer to Note H of the Notes to the Consolidated Financial Statements - Unpaid Loss and Loss Adjustment Expenses.
Underwriting and other expenses as a percentage of net premiums earned increased from 16.2% in 1997 to 19.5% in 1998. The increase is primarily due to a $10 million termination fee relative to the Company's aggregate excess stop loss agreement for the 1999 treaty year, an increase in the allowance for doubtful accounts of approximately $3.5 million and a restructuring charge of $0.3 million related to the closing of one of the Company's Health Care Division offices. Underwriting and other expenses were also higher in 1998 due to the move of the Surety Division to Nashville and costs incurred related to a start-up business unit within the Specialty Programs Division.
The Company invests primarily in fixed income securities with the objective of maximizing after-tax investment income and total investment returns within approved investment guidelines. The core investment portfolio contains fixed maturity securities which are rated investment grade. At December 31, 1999, the Company held investment grade rated securities with a carrying value of $1.13 billion, representing 97.4% of total fixed maturity investments. Fixed maturity investments with credit ratings below investment grade, which are maintained as part of the alternative investment portfolio, totaled $30.5 million at December 31, 1999 and represented the 2.6% balance of the total fixed maturity investments.
The alternative investment portfolio includes investments in limited partnerships with carrying values of $43.1 million and $27.3 million at December 31, 1999 and 1998, respectively. The partnerships have varying investment strategies and these investments were made by the Company with the objective of long-term capital
S&P has suspended its financial strength rating of BB+ ("Marginal") on all of the Company's insurance subsidiaries, which currently are not rated by S&P.
The thrust of these regulatory efforts is to improve the solvency of insurance companies. These regulatory initiatives, and the overall focus on solvency, may intensify the restructuring and consolidation of the insurance industry. The impact of these regulatory efforts on the Company's operations cannot be quantified until enacted.
Over the past decade, the Company has been engaged in litigation with the State of New York as to whether physician medical school faculty members at the State University of New York ("SUNY") engaged in the clinical practice of medicine at a SUNY medical school facility, corollary to such physicians' faculty activities, were within the scope of their employment by SUNY, and thereby protected against malpractice claims arising out of such activity by the State, or by the Company under its medical malpractice policies insuring the SUNY physicians. As a result of favorable judicial decisions in the New York Court of Claims (the "Court of Claims") which were ultimately affirmed by the State's highest court, the Court of Appeals, the Company recorded subrogation recoverables for claims previously paid and reserves established with respect to such malpractice claims of approximately $19 million on December 31, 1995 and $13 million on June 30, 1996.
In September 1998, the Company and the State reached an agreement with respect to the 83 cases currently being litigated in the Court of Claims pursuant to which the Company received $15 million.
Property and casualty insurance premiums are established before the amount of losses and LAE, or the extent to which inflation may affect such expenses, are known. Consequently, the Company attempts, in establishing its premiums, to anticipate the potential impact of inflation. However, for competitive and regulatory reasons, the Company may be limited in raising its premiums commensurate with anticipated inflation, in which event the Company, rather than its insureds, would absorb inflation costs. Inflation also affects the rate of investment return on the Company's investment portfolio with a corresponding effect on the Company's investment income.
In prior filings, the Company discussed the nature and progress of its plans to become Year 2000 ready. In late 1999, the Company completed its remediation and testing of its information technology ("IT") systems. As a result of those planning and implementation efforts, the Company experienced no significant disruptions in mission critical IT systems and believes those systems successfully responded to the Year 2000 date change.
Costs incurred in connection with remediating the Company's systems, amounted to approximately $3 million, including approximately $1 million during 1999. The Company is not aware of any material problems resulting from Year 2000 issues, either with its internal systems, or the products and services of third parties. The Company will continue to monitor its mission critical computer applications and those of its suppliers and vendors throughout the year 2000 to ensure that any latent Year 2000 matters that may arise are addressed promptly.
The Company also conducted a comprehensive review of its underwriting guidelines and obtained regulatory approval from most jurisdictions to add an endorsement to commercial property and casualty policies to clarify that coverage is not afforded losses resulting from Year 2000 noncompliance by insureds. This endorsement was added to the majority of commercial policies issued or renewed in 1999. Underwriting policy and protocol were developed to address nonapproving jurisdictions and business situations that cannot be endorsed. To date, Year 2000 claims reported to the Company have been minimal. For these reasons, the Company believes its exposure to Year 2000 claims will not be material to its operations or financial condition. However, due to social and legal trends, it is impossible to predict what, if any, exposure insurance companies generally may have relating to Year 2000 claims.
or property damage caused by exposure to asbestos, other than for the policies providing coverage to asbestos abatement contractors for third party claims alleging bodily injury or property damage as a result of exposure to asbestos. Employees of the insured contractor and others required to be in the abatement area are excluded from coverage.
Following the Company's November 5, 1994 announcement of its third-quarter financial results, the Company was served with seven purported class actions alleging violations of federal securities laws by the Company and, in some cases, by certain of its officers and directors. In September 1995, a pre-trial order was signed which consolidated all actions in the Eastern District of New York, appointed three law firms as co-lead counsel for the plaintiffs and set forth a timetable for class certification, motion practice and discovery. In November 1995, plaintiffs served a consolidated amended complaint alleging violations by the Company of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10(b)(5) thereunder, seeking to impose controlling person liability on certain of the Company's officers and directors, and further alleging insider sales, all premised on negative financial information that should have been publicly disclosed earlier. Plaintiffs seek an unspecified amount in damages to be proven at trial, reasonable attorney fees and expert witness costs. In April 1997, the Court certified the class. Plaintiffs have subpoenaed documents and deposed outside auditors and analysts. Plaintiffs have also taken depositions from current or former officers, directors and employees of the Company.
In June 1999, plaintiffs were granted permission to amend their complaint and to reopen discovery to take additional depositions and request additional documents. The additional depositions have been taken. In February 2000, the plaintiffs made an additional motion to amend their complaint wherein they seek to have the class period, which presently runs from February 10, 1994 through November 8, 1994, extended to November 15, 1999. The motion also seeks to add an additional plaintiff and defendant. Plaintiffs also seek to allege that increases in reserves taken by the Company in various reporting periods subsequent to November 1994 evidence an ongoing fraud. The Court has not ruled on this motion.