For purposes of this management discussion and analysis, the term "Company" refers to Medical Assurance, Inc. and its consolidated subsidiaries. The consolidated subsidiaries consist principally of operating insurance companies.
The Company did not borrow any funds during the years ended December 31, 1999 and 1998, and currently has no requirements indicating a need to borrow significant funds in the next twelve months. However, the need for additional capital may arise in order to achieve the Company's goals of business expansion, as discussed previously in Item 1. The Company continues to have available through a lending institution a line of credit in the amount of $40 million that could be used for these additional capital requirements. The Company is not charged a fee nor is it required to maintain compensating balances in connection with this line of credit. Additionally, in an effort to protect the Company's investment portfolio against the possibility of higher interest rates in the future, the Company reduced the average maturity of a portion of that portfolio during the third and fourth quarters of 1998. This reduction was the principal reason for the higher gross realized gains in 1998 as discussed in Note 2 of the accompanying Notes to Consolidated Financial Statements.
During 1999, the Company's Board of Directors increased the authorization for purchases of its common stock by $10.0 million in March and by an additional $10.0 million in August. The Company purchased approximately 1.1 million shares of its stock in 1999 at a cost of approximately $27.9 million. Treasury shares purchased during each quarter of 1999 and the related cost (both approximate) are as follows: during the first quarter 126,000 treasury shares at a cost of $3.6 million, during the second quarter 205,000 shares at a cost of $5.6 million, during the third quarter 632,000 shares at a cost of $15.6 million, and during the fourth quarter 133,000 shares at a cost of $3.1 million. Share amounts give effect to the 1999 stock dividend. At December 31, 1999 the Board purchase authorization had effectively been exhausted.
Effective January 1, 1999, the Company purchased the ongoing book of medical professional liability insurance business of Medical Defense Associates (MDA) and Medical Defense Insurance Company (MDIC). The Company has assumed day-to-day management of existing policies and prior liabilities of MDA and MDIC and provides aggregate excess of loss reinsurance to protect MDA and MDIC from adverse loss development in excess of an agreed upon threshold.
At December 31, 1999 the Company has a limited investment in preferred stocks. These securities were carried at fair value of $18.6 million at December 31, 1999, including net unrealized losses of $0.1 million. These securities carry fixed rates of return and thus, like fixed maturities, are primarily subject to interest rate risk. The fixed maturities table above does not include preferred stocks.
The Company's cash and short-term investment portfolio at December 31, 1999 on a cost basis which approximates its fair value. This portfolio lacks significant market rate sensitivity due to its short duration.
In 1996, as a part of its ongoing efforts to maintain effective and efficient operations, the Company committed to and began replacing substantially all the software and hardware used in its core computer information system. Year 2000 compliance was an integral consideration of the selection and implementation process for these systems. Implementation of the component systems, which included testing for Year 2000 compliance, was completed in mid-1999. Because Year 2000 compliance was incidental to the implementation of the systems, costs specifically related to Year 2000 compliance have been minimal.
The largest component of the increase in direct and assumed premiums written was a $17.2 million increase in medical malpractice premiums. The increase in medical malpractice premiums includes assumed premiums of $3.9 million effective January 1, 1999 from the existing policies of the book of business acquired from MDA and MDIC, as discussed under Liquidity and Capital resources, an increase in assumed medical malpractice premiums of $1.9 million, and $6.6 million of additional direct premiums resulting from the renewal of the book of business purchased from MDA. Offsetting the increase in medical malpractice premiums was a $10.5 million decrease in accident and health premiums.
The Company cedes reinsurance to provide for greater diversification of business, allow management to control exposure to potential losses arising from large risks, and provide capacity for additional growth. Premiums ceded are estimated based on the terms of the respective reinsurance agreements. The estimated expense is continually reviewed and any adjustments that become necessary are included in current operations. Amounts recoverable from reinsurers are estimated in a manner consistent with the loss liability associated with the reinsured policies. The decrease in premiums ceded for the year ended December 31, 1999 as compared to the year ended December 31, 1998 is principally due to the decrease in earned accident and health premiums, which are heavily ceded. The remaining decrease is due to a greater proportion of premiums earned in states where cession levels are lower. The Company continually reviews the levels of coverage ceded and the related costs.
Consolidated net investment income was $39.3 million for the year ended December 31, 1999 which was relatively unchanged as compared to net investment income of $39.4 million for the year ended December 31, 1998. The average yield on invested assets was 5.2% in 1999 as compared to 5.6% in 1998. The decline in yield was largely offset by an increase in average invested assets during 1999.
The principal investment objective of the Company is to achieve a high level of after-tax income while minimizing risk. Although fixed maturity securities are purchased with the initial intent to hold such securities until their maturity, disposals of securities prior to their respective maturities may occur if management believes such disposals are consistent with the Company's overall investment objectives, including maximizing after-tax yields.
These loss ratios give effect to improvement of loss development in prior years' coverage of $53.6 million in 1999 and $47.3 million in 1998. However, as the Company continues its expansion efforts, the improvement of loss development of prior years could have a smaller or less favorable impact on the loss ratios of future years. See Note 6 of the Notes to Consolidated Financial Statements for additional information concerning losses.
The following table presents information related to consolidated written and earned premiums and reinsurance expense (in thousands):
Premiums earned for the year ended December 31, 1998 increased $37.4 million as compared to the year ended December 31, 1997, primarily attributable to premiums earned from physician malpractice coverage and other new business written in late 1997 in states other than Alabama.
The Company had consolidated net investment income of $39.4 million for the year ended December 31, 1998 as compared to $38.5 million for the year ended December 31, 1997 reflecting an increase of approximately $900,000. The increased income is primarily due to an increase in the amount of invested assets offset somewhat by a decrease in the yield. Invested assets increased to $761.1 million at December 31, 1998 from $681.1 million at December 31, 1997. The yield on invested assets decreased to 5.6% for 1998 from 5.9% for 1997. The average composition of invested assets changed little to 1998 from 1997, with non-taxable investments comprising an average of 54% for 1998 and 58% for 1997.
The increase in the 1998 gross loss ratios reflects continued geographic expansion and additional coverages offered. When expanding into areas where the Company has no significant prior loss experience, the Company follows loss estimation processes, which result in higher gross loss ratios. Additionally, the Company reinsures a higher proportion of these risks, thereby lowering the net loss ratio. Thus, the 1998 net loss ratio of 66% did not vary significantly from the 1997 net loss ratio of 65%.
The Company's effective tax rate for the years ended December 31, 1998 and 1997 was 26% and 24%, respectively. The effective tax rates were lower than the statutory rate of 35% primarily because of the effect of tax-exempt investment income. The increase is principally due to the tax-exempt income representing a lesser percentage of operating income in 1998. There are no loss carryforwards included in the deferred tax asset.
The U.S. securities laws, including the Private Securities Litigation Reform Act of 1995, provide a "safe harbor" for certain forward-looking statements. This report contains forward-looking statements (identified by words such as, but not limited to, "believe", "expect", "intend", "anticipate", "estimate", and other analogous expressions) including statements concerning: earnings, losses, capital requirements, loss reserves, the retention of current business, competition, the expansion of product lines, the development or acquisition of business in new geographical areas, and other matters.
These forward-looking statements are based upon the Company's estimates and anticipation of future events that are subject to certain risks and uncertainties that could cause actual results to vary materially from the expected results described in the forward-looking statements. Due to such risks and uncertainties, readers are urged not to place undue reliance on forward-looking statements. All forward-looking statements included in this document are based upon information available to the Company on the date hereof, and the Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
- underwriting losses on the risks the Company insures are greater than expected; - changes in the interest rate environment and/or the securities markets that adversely impact the fair value of the Company's investments or operations; - regulatory and legislative actions or decisions that adversely affect the Company's business plans or operations; - inability of the Company to achieve continued growth through expansion into other states or through acquisitions or business combinations; and - general economic conditions that are worse than anticipated