The following table summarizes certain selected historical consolidated financial data with respect to the Company and is based upon the historical consolidated financial statements of the Company. The information set forth below should be read in conjunction with ``Management's Discussion and Analysis of Financial Condition and Results of Operations,'' and the Consolidated Financial Statements and related notes thereto included elsewhere herein.
Property and casualty insurers are regulated by the various state insurance departments that coordinate their efforts through the NAIC. See ``Business-- Regulation.'' Regulation includes rate and policy form approval, licensing of insurance agents and companies and solvency oversight.
Net Premiums Earned. Net premiums earned for 2000, 1999 and 1998 were $388.5 million, $325.3 million and $388.8 million, respectively. The increase in 2000 compared to 1999 is related to the same items affecting gross and net premiums written as noted above, but also reflects the recognition of net premiums earned over the coverage period rather than when the premiums were written. Additionally, the Company reestimated the premiums due under retrospective policies, reducing such assets by $11.0 million. The decrease in 1999 compared to 1998 is related to the same items affecting gross and net premiums written as noted above including the 1998 termination of the Stop Loss Agreement, which increased reported net earned premiums in 1998 by $34.6 million.
Loss and Loss Adjustment Expense Incurred. Loss and loss adjustment expense incurred for 2000, 1999 and 1998 was $346.1 million, $238.9 million and $328.4 million, respectively. The loss and loss adjustment expense ratios for 2000, 1999, and 1998 were 89.1%, 73.5% and 84.4%, respectively. During the fourth quarter of 2000, the Company, along with its independent actuary, determined that there had been adverse development in the commercial multiple peril and workers' compensation lines. Following this analysis, loss and loss adjustment expense reserves were increased at the end of 2000 by approximately $48.0 million, covering those lines as well as increases and decreases in other lines. The increase in reserves affected current as well as prior year business, and increased the 2000 calendar year loss ratio by approximately 12.1 points, excluding the affects of certain reserve adjustments on retrospective rated policies which were off-set by increases in net premiums earned. The decrease in 1999 of $89.5 million compared to 1998 was primarily attributable to three factors. First, the 1998 termination of the Stop Loss Agreement noted above had the effect of increasing loss and loss adjustment expenses reported in 1998 by $50.0 million. Second, in 1999, the Company experienced a decrease in loss and loss adjustment expenses of $19.1 million related to California construction defect claims because, in 1999, the Company recorded additional reinsurance recoverables for previously unbilled paid losses of $11.1 million related to California construction defect claims, while in 1998, the Company had $8.0 million of unfavorable reserve development for these claims. Third, the Company experienced a decrease in loss and loss adjustment expenses of approximately $4.1 million related to weather related catastrophe losses. Finally, in 1998, there were higher incurred losses subject to retrospectively rated policies.
Underwriting Expenses. Underwriting expenses for 2000, 1999 and 1998 were $134.5 million, $130.1 million and $141.8 million, respectively. The underwriting expense ratios for 2000, 1999 and 1998 were 34.6%, 40.0% and 36.5% respectively. The decline in the 2000 underwriting expense ratio, compared to the 1999 expense ratio, of 5.4 points to 34.6%, resulted from expense savings initiatives instituted in 1999, principally reducing systems out-sourcing costs by $5.1 million and reducing salary and benefits by $3.5 million. Additionally, lower fixed costs were spread over higher premium volume in 2000. The decline in the 1999 underwriting expense ratio, compared to the adjusted 1998 expense ratio, is the result of the Company's 1999 expense saving initiatives. During 1999, the Company realized expense savings of $2.4 million due to the 1998 termination of the Stop Loss Agreement and $1.6 million related to restructuring a system vendor agreement. These savings were partially offset by a restructuring charge in the amount of $780,000 and additional expenses associated with the Company's 1999 system integration projects. Elimination of the 1998 non-recurring additional premium related to the Stop Loss Agreement and certain unusually large 1998 retrospectively rated policy adjustments resulted in an adjusted expense ratio of 41.8% for 1998.
Investment Results. Net investment income for 2000, 1999 and 1998 was $62.5 million, $67.7 million and $78.0 million, respectively. Net investment income decreased $5.2 million in 2000 compared to 1999 primarily due to a reduction in the investment portfolio's average amortized cost. Net investment income decreased $10.3 million in 1999 compared to 1998 due to declining premium volume in 1999 and 1998, continued reduction of the investment portfolio's average amortized cost due to the payment of older loss reserves, and the 1998 repurchase of Company Common Stock.
Other Income (Expenses), Net. This consists of parent company expenses and miscellaneous expenses from the insurance subsidiaries offset by miscellaneous income. During 2000, the Company recognized as income: (i) $1.3 million associated with a reserve guarantee finalized in 2000 (see Note 3 of Notes to the Consolidated Financial Statements); (ii) a reduction of the bonus accrual of $1.8 million associated with the Management Investor's Purchase Agreement (see Note 8 of Notes to the Consolidated Financial Statements); and (iii) a reduction of $1.8 million of other accruals.
Income Taxes. During 2000, the Company increased its valuation allowance for deferred tax assets by $82.8 million. Based on the results of operations, management does not currently believe that it is more likely than not that the tax benefits for which it increased the valuation allowance will be realized in the near future. Total tax expense for 2000 was $67.7 million and reflects the increase in valuation allowance. The total tax expense for 1999 was $13.0 million. In 1999, the Company recorded a charge totaling
Highlands Group is a holding company, the principal assets of which at December 31, 2000 are all of the capital stock of Highlands Holding Company, Inc. and American Reliance, Inc. The Company's property and casualty insurance business is conducted by its direct and indirect wholly-owned insurance subsidiaries. The liquidity and capital resource considerations for the Highlands Group are different than those of the Company's insurance operations.
As a holding company, Highlands Group's principal requirements for funds are to pay operating expenses, franchise and other taxes and debt service. Operating expenses and franchise and other taxes imposed on the Company are not expected to be material. The annual cash interest requirements relating to the Company's outstanding 10% convertible subordinated debentures (the "Debentures") and the loan under the Credit Agreement are approximately $10.0 million. At the end of 2000, the Company was in default of certain covenants, including financial covenants, in the Credit Agreement. Effective December 31, 2000, the Company and the lenders entered into an Amendment and Waiver Agreement which amended the Credit Agreement thereby eliminating the defaults. There can be no assurance that the Company will be able to comply with the amended covenants in the Credit Agreement. A default under the Credit Agreement which is not cured or waived gives the lenders the right to declare the entire loan under the Credit Agreement, $49 million at December 31, 2000, in default, accelerate the maturity of the loan and seek repayment, including seeking to execute on the collateral for the loan, i.e., the stock of the Company's principal insurance subsidiaries. The Debentures in the principal amount of $62.85 million are due December 31, 2005; however, by virtue of the cross-default provisions of the Debentures, if the loan under the Credit Agreement is in default and the payment of the debt is accelerated, the holders of the Debentures have the right to declare the Debentures in default and accelerate their maturity. Also, at the end of 1999, the Company was in default under certain financial covenants in the Credit Agreement. Effective December 31, 1999, the Company and its lenders amended the Credit Agreement to revise those financial covenants and to provide for the payment of $10.0 million in principal during 2000.
As stated above, annual cash interest payments under the Credit Agreement and the Debentures approximate $10 million. Furthermore, even in the absence of defaults, the loan under the Credit Agreement is due and payable on April 30, 2002. The Company is taking a number of steps to deal with these requirements.
A Special Committee was formed by the Board of Directors of the Company on March 29, 2001 in connection with the Company's exploration of engaging in one or more transactions, including without limitation one or more of the following: a merger, consolidation or sale of all or a portion of its business or assets; an acquisition of another company or business; obtaining an investment in the Company; a joint venture or other joint endeavor (including creating a new entity to effect any such venture or endeavor); a strategic or other transaction (a ``Transaction''). The Special Committee was formed to avoid potential conflicts of interest. The Company may not take any action with respect to a proposed Transaction unless such proposed Transaction is recommended for approval to the full Board of Directors of the Company by the Special Committee evidenced by a resolution duly adopted by the Special Committee. The powers and authorities of the Special Committee include to retain independent legal, accounting, actuarial or other advisors to advise the Special Committee in connection with any proposed Transaction; to obtain reports (including without limitation one or more fairness opinions) concerning proposals for one or more Transactions; to cause its financial advisors to solicit indications of interest from one or more persons or entities with respect to engaging in a Transaction; to negotiate the form, terms and provisions of any proposed Transaction; to consider and approve or disapprove any and all agreements (subject to the ultimate authority of the full Board of Directors of the Company, upon recommendation of the Special Committee, to approve any definitive agreement in connection with any Transaction) related to a proposed Transaction; and to recommend to the full Board of Directors of the Company the approval or disapproval of any proposed Transaction. The Company has retained two independent investment advisors to advise the Special Committee in connection with any proposed Transaction. The Special Committee consists of four Non- Employee Directors: Messrs. Hawk, Pieper, Williams and Shower. See Part III, Item 10. "Directors and Executive Officers of the Registrant."
In the insurance industry, liquidity refers to the ability of an enterprise to generate adequate amounts of cash from its operations, including its investment portfolio, in order to meet its financial commitments, which are principally obligations under the insurance policies it has written. Liquidity requirements of insurance companies are influenced significantly by product mix and the profitability of the products. Continuing operating losses, including those from future catastrophe claims, the timing and amount of which are inherently unpredictable, may create increased liquidity requirements for the insurance subsidiaries. The liquidity requirements of the insurance subsidiaries are met by that portion of the investment portfolio that is held in cash and highly liquid securities.
Based on the Company's evaluation of the financial condition of its reinsurers, the Company has established reserves for potentially uncollectible reinsurance of $7.4 million and $2.2 million as of December 31, 2000 and 1999, respectively. Additionally, the Company has retained $25.1 million and $25.6 million of ceded reserves related to potentially uncollectible reinsurance at December 31, 2000 and 1999. With respect to carriers that are not authorized reinsurers as determined by the appropriate department of insurance, the Company often receives collateral primarily in the form of bank letters of credit generally securing the reinsurance recoverable regarding reported losses and in some instances unreported losses. At December 31, 2000, such collateral totaled approximately $22.8 million. The Company's three largest reinsurance recoverable exposures at December 31, 2000 were approximately $141.1 million with Lloyds of London/Equitas, $84.1 million with American Reinsurance Company and $55.8 million with General Reinsurance Company. American Reinsurance Company and General Reinsurance Company are rated by A. M. Best ``A+'' and ``A++'', respectively.
The statements included in this Annual Report on Form 10-K for the fiscal year end December 31, 2000, regarding future financial performance and results and other statements that are not historical facts are forward-looking statements. The words ``expect,'' ``project,'' ``estimate,'' ``predict,'' ``anticipate,'' ``believes'' and similar expressions are also intended to identify forward- looking statements. Such statements are subject to numerous risks, uncertainties and assumptions, including but not limited to, the uncertainties relating to industry and market conditions, natural disasters and other catastrophes, and other risks and uncertainties described in this 2000 Annual Report and in the Company's other filings with the Securities and Exchange Commission. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual outcomes may vary materially from those indicated.