Program Business involves replacing traditional insurers and acting as the conduit between producers of specialty books of business and reinsurers wishing to write that business. Program Business accounted for 53% of total Fees for 1999 compared to 52% in 1998 and 41% in 1997. This growth has resulted from the continued expansion of this business as a result of reinsurers' increased appetite for premium volume in the current soft market. Fees earned on individual Program accounts are more likely to grow compared to Corporate accounts because new policy holders are constantly being added in each program. Program Business also has historically had a higher retention rate than Corporate Risk Management. Pre-tax margins in this segment were 28% for 1999 compared to 40% in 1998 and 39% in 1997. The second half of 1999 saw a decline in the growth rate and margins in this segment as a result of a decline in premium rates, especially at the Company's underwriting management subsidiary, Small Business Underwriters.
Historically, workers' compensation has been the major line of business written by the Company in both its Corporate Risk and Program Business segments. Generally, competition for workers' compensation business has increased in recent years and the resulting under-pricing of workers' compensation risks by traditional insurers has reduced the incentive for insureds to enter "Alternative Market" vehicles such as those offered by the Company in its Corporate Risk Management segment. However, the Company is beginning to see price increases in a number of lines, particularly in California workers' compensation and in accident and health across the U.S., resulting in increased submission activity.
The Company's Specialty Brokerage business segment provides access to Alternative Risk Transfer insurers and reinsurers in Bermuda and Europe. Fees in this segment grew by 52% in the year as a result of increased business placed in Bermuda and London. Profit margins improved to 38% from 25% in 1998 and 31% in 1997 primarily as a result of the increased revenues.
increased primarily as a result of an increase in the number of mutual funds under management from 129 in 1997 and 195 in 1998, to 279 in 1999. Profit margins decreased from 26% in 1997 to 4% in 1998, and improved to 7% in 1999. Margins in the Financial Services segment were adversely affected in both 1998 and 1999 by the previously announced revised Executive Incentive Plan implemented in 1998. The effect of this revised Executive Incentive Plan will continue through 2000. Excluding the effect of the revised Executive Incentive Plan, the profit margins in this segment would have been 17% and 18% for the years ended December 31, 1999 and 1998 respectively.
The Company generally requires each Corporate Risk Management client to indemnify it against an underwriting loss and the client normally provides collateral for at least the difference between the funds available in that client's account and the level of expected losses as actuarially determined by the Company, although in certain circumstances the collateral level is below the level of expected losses. This is also the case for Program Business clients who participate in the IPC Programs. For Program Business clients that do not participate in the IPC Programs, reinsurance protection is purchased by the Company to minimize its underwriting risk.
The Company has established provisions for losses as a result of these exposures for certain clients.These provisions, which totaled $18.0 million at December 31, 1999, $7.3 million in 1998 and $5.6 million in 1997, reduced the level of Fee income in each year by $3.1 million, $.9 million and $1.1 million respectively. These provisions also adversely impacted the underwriting results in each year by $7.6 million, $.8 million and $0 in 1999, 1998, and 1997 due to programs where losses exceeded reinsurance limits and uncollected premiums. The increase in provisions from 1998 to 1999 relates primarily to provisions established in the third quarter on a number of terminated programs. The 1999 provisions are net of a reinsurance recovery of $14.7 million under a contingency excess of loss policy. The increase in the number of accounts and their inherent growth in premium volume, the increase in the clients' aggregate retentions since 1991, the amounts recoverable from reinsurers, which amounted to $2.0 billion at December 31, 1999 and $1.3 billion at December 31, 1998, in addition to competitive factors which have limited the amount of collateral that clients are willing to provide, have significantly increased the Company's exposure to such losses. The Company evaluates the financial condition of its clients, brokers and reinsurers to minimize its exposure to losses from insolvencies.
Premiums earned increased by 78% in 1999, 21% in 1998 and 49% in 1997. These increases are attributable to the shift in business from the Corporate Risk Management segment to the Program Business segment and the strong growth within this segment. Program Business usually involves higher premiums than business derived from the Corporate Risk Management segment due to new policies constantly being added by agents. Premiums earned represent the net premiums retained by the Company on which it bears underwriting risk. The Company believes that both the volatility of underwriting profit or loss and the probability of experiencing a severe underwriting loss are less than would ordinarily be expected for a traditional property/casualty insurer, due to the nature of the business written by the Company and the structure of its reinsurance. In the past, the level of Premiums earned has been closely matched by the level of Total insurance costs, resulting in small amounts of underwriting loss as a percentage of Premiums earned. However, in 1999, Losses incurred under certain
Included in Premiums earned are assigned risk premiums of $1.8 million in 1999 as compared to $2.5 million in 1998 and $8.4 million in 1997. The underwriting losses associated with these assigned risk premiums, together with other charges imposed by certain states on voluntary insurers such as Legion to support involuntary market losses ("residual market loads"), are passed on by Legion to clients' accounts.
The breakdown of expenses for each of 1999, 1998 and 1997 is set forth in Table III.
The increases in Total insurance costs are typically the direct result of the increases in Premiums earned during the relevant period. However, Total insurance costs during 1999 exceeded the increase in Premiums earned. During the year, the Company established a provision related to net losses incurred on a number of terminated programs of $8 million net of tax. This resulted in a $12.3 million increase in Losses and loss expenses incurred offset by a $4.3 million reduction in Income taxes. Losses incurred also increased as a direct result of the decreased use of large deductible policies and the increase in Program Business. The 27% decrease in Acquisition costs from 1997 to 1998 is due to the reduction in the number of deductible programs, which have high expense levels; the loss of one large account that was fully retained; and reduction in expenses charged by the assigned risk pools.
The charges for Income taxes represent effective tax rates of 17.6%, 11.7% and (.7)% in 1997 through 1999 respectively. The reduced tax rate in 1998 and 1999 is due to increased earnings outside of the United States. The tax rate in 1999 was reduced further by the provisions on terminated programs. These factors, plus interest earned on tax-fee municipal securities and the tax benefit derived from the exercise of employee stock options, are the major causes of the difference between the expected federal income tax rate in the United States of 35% plus state income taxes and the Company's effective rates in the year. The Legion Companies, as insurance companies in the United States, are subject to income tax on an accelerated basis and, as a result, a deferred tax benefit was carried on the Consolidated Balance Sheets of $4.2 million in 1999 and $.9 million in 1998.
At December 31, 1999 the market value of the Company's Total marketable investments was $607 million, as compared to $580 million at December 31, 1998. In accordance with SFAS 115, Investments available for sale are reported at fair market value with unrealized gains and losses included as a separate component of Shareholders' equity. These Investments generally consist of investment grade fixed-income securities that the Company believes are readily marketable and could be liquidated to meet cash requirements, if necessary.
Cash flow from operations has historically provided the Company its principal source of liquidity. The Company has continued to produce a positive cash flow with $20.6 million of cash provided from operations during 1999, as compared to $62.4 million in 1998 and $56.4 million in 1997. Cash flow in 1999 was adversely affected by delays in recovering reinsurance payments in the Company's Program Business segment but improved in the second half of 1999 from the first and second quarters.
The Company recently established a $250 million bridge loan facility, $117 million of which was outstanding at December 31, 1999. The Company made an additional contribution to the policyholders' surplus of its U.S. insurance companies in the amount of $110 million from this facility. As of December 31, 1999, the Company had repurchased $14 million face amount of its Convertible Exchangeable Subordinated Debentures due 2015 at a cost of $6.3 million, also from this facility. The Company expects to refinance this bridge loan facility with permanent financing during 2000, and recently filed an S-3 Shelf Registration Statement with the U.S. Securities and Exchange Commission for the future issuance of $500 million of debt and preferred securities.
The Company believes that funds generated from operations and available credit will be sufficient to finance its current operations and to fund the repurchase of the remaining Convertible Exchangeable Subordinated Debentures as well as the 2.4 million remaining Common Shares of the Company's 5.0 million share repurchase authorization.
Shareholders' equity increased 4% to $358 million at December 31, 1999 from $343 million at December 31, 1998. This increase was attributable to Net income in 1999, less dividends paid, plus the value of shares issued on the exercise of employee stock options, and the conversion of debentures. During 1999 the total number of Common Shares outstanding decreased to 41,205,191 from the 1998 level of 42,205,596, mainly as a result of the Company repurchase of 2.6 million shares in the fourth quarter at an average price of $11.31 per share. This decrease in Common Shares outstanding for the year was partly offset by the conversion of debentures and the exercise of employee stock options.
Total assets increased to $4.0 billion at December 31, 1999, a 31% increase from $3.1 billion at December 31, 1998. $693.4 million, or 17% of Total assets in 1999 and $722.3 million, or 23%, in 1998 related to Assets held in separate accounts. As detailed in Note 2A to the Consolidated Financial Statements, such assets are principally managed assets attributable to participants in the Company's IPC Programs. Total assets also increased due to the increase in Reinsurance receivables from $1,079.6 million in 1998 to $1,729.9 million in 1999. This increase, which is largely offset by corresponding increases in the Reserve for losses and loss expenses and Accounts payable, is due to the greater amount of reinsurance utilized in connection with the Company's Program Business segment.
The Company does not believe its operations have been materially affected by inflation. The potential adverse impacts of inflation include: (a) a decline in the market value of the Company's fixed maturity investment portfolio; (b) an increase in the ultimate cost of settling claims which remain unresolved for a significant period of time; and (c) an increase in the Company's Operating expenses. However, the Company generally holds its fixed maturity investments to maturity and currently believes that an acceptable amount is included in the yield to compensate the Company for the risk of inflation. In addition, any increase from inflation in the ultimate cost of settling unpaid claims will be borne by the Company's clients and offset by investment income earned for the benefit of the client during the period that the claim is outstanding. Finally, the increase in Operating expenses resulting from inflation should generally be matched by similar inflationary increases in the client's premium and the Company's Fee income, which includes a fee based upon a percentage of the client's premium.
Interest rate risk results from the Company' holdings in interest-rate- sensitive instruments. The Company is exposed to potential losses arising from changes in the level or volatility of interest rates on fixed rate instruments held. The Company is also exposed to credit spread risk resulting from possible changes in the issuer's credit rating. To manage its exposure to interest rate risk the Company attempts to select investments with characteristics that match the characteristics of the related insurance and contract holder liabilities. Additionally, the Company generally only invests in higher-grade interest bearing instruments.
The Company has not experienced any significant Year 2000 issues to date. All systems identified for replacement before the Year 2000 were replaced. Since the Company regularly updates its hardware and software, the pure additional cost of Year 2000 compliance was not material.
The Company has taken steps that it believes are reasonably designed to obtain assurances that its critical customers, reinsurance intermediaries, managing general agents, suppliers and others have addressed their Year 2000 compliance efforts. Although the change in date to Year 2000 has occurred, it is not possible to conclude that all aspects of the Year 2000 issue that may affect the Company relating to other third party providers have been fully resolved. The inability of the Company's third party providers to properly address the Year 2000 issue could have an adverse material impact on the Company's financial position or results of operations. Management will continue to monitor the status of and its exposure to this issue, however, the Company has not experienced any significant Year 2000 issues to date. Contingency plans are still in place should critical customers, reinsurance intermediaries, managing general agents, suppliers and others fail to resolve their own Year 2000 issues. To date, the Company has not been notified of any Year 2000 related claims.
During the first quarter of 2000, the Company repurchased convertible Debentures representing a principal amount of $222 million in the open market at a cost of $101.3 million. The repurchased debentures were convertible into $4.8 million Common Shares and their repurchase will result in a one-time extraordinary loss of approximately $4.3 million, net of tax.
In connection with the "safe harbor' provisions of the Private Securities Litigation Reform Act of 1995 (the "Act"), the Company sets forth below cautionary statements identifying important factors that could cause the Company's actual results to differ materially from those which might be projected, forecasted, or estimated or otherwise implied in the Company's forward-looking statements, as defined in the Act, made by or on behalf of the Company in press releases, written statements or documents filed with the Securities and Exchange Commission, or in its communications and discussions with investors and analysts in the normal course of business through meetings, telephone calls and conference calls. Such statements may include, but are not limited to, projections of Fee income, Premiums earned, Net investment income, Other income, Losses and loss expenses incurred, Acquisition costs, Operating expenses, Other expenses, earnings (including earnings per share), cash flows, plans for future operations, Shareholders' equity, financing needs, capital plans, dividends, plans relating to products or services of the Company, and estimates concerning the effects of litigation or other disputes, as well as assumptions for any of the foregoing and are generally expressed with words such as "believes", "estimates", "expects", "anticipates", "could have", "may have", and similar expressions.
Forward-looking statements are inherently subject to risks and uncertainties. The Company cautions that factors which may cause the Company's results to differ materially from such forward-looking statements include, but are not limited to, the following: (a) Changes in the level of competition in the reinsurance or primary insurance markets that adversely affect the volume or profitability of the Company's business. These changes include, but are not limited to, the intensification of price competition, the entry of new competitors, existing competitors exiting the market, and the development of new products by new and existing competitors; (b) Changes in the demand for reinsurance, including changes in ceding companies'retentions, and changes in the demand for primary and excess and surplus lines insurance coverages; (c) The ability of the company to execute its business strategies and its reliance on key personnel; (d) Adverse development on claims and claims expense liabilities related to business and the failure of clients, reinsurers or others to meet their obligations to the Company in connection with such losses.