Future minimum rental charges for ACGL, Hales and American Independent for the remaining terms of their subleases, exclusive of escalation clauses and maintenance costs and net of rental income, will be approximately $1,968,700. For 2000, 1999 and 1998, our rental expense, net of sublease income, was approximately $190,000, $576,000 and $576,000, respectively.
We believe that the above described office space is adequate for our current and anticipated needs.
The following consolidated historical financial data for the five-year period ended December 31, 2000 should be read in conjunction with our audited consolidated financial statements and the related notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations."
As of December 31, 2000, we had $75.8 million of cash and short-term investments (of which $10.75 million was used in connection with our acquisition of, and related capital contribution to, American Independent in February 2001), $28.6 million of fixed maturity investments, and $49.4 million of publicly traded equity securities. As of that date, investments that are restricted or generally unavailable for liquidity purposes included $44.8 million of privately held securities and $21.0 million of fixed maturity investments held in escrow in connection with the sale of our reinsurance operations. In addition, we have an investment commitment relating to our privately held investment in Trident II totaling approximately $18.2 million. See note 4 of the notes accompanying our consolidated financial statements, "Business--Significant 2000 Developments--Sale of Reinsurance Operations" and "--Acquisitions." Amounts discussed above do not include the stock of our subsidiaries.
Net cash flow from operating activities for the years ended December 31, 2000, 1999 and 1998 was approximately $2.6 million, $7.5 million and $68.5 million, respectively. For the period from January 1, 2000 to May 5, 2000 and for the years ended December 31, 1999 and 1998, cash flow included premiums received and investment income (excluding net realized investment gains), offset by operating costs and expenses. For the three years ended December 31, 2000, cash flow included investment income (excluding net realized investment gains), offset by operating costs and expenses. Our future net cash flow will depend on the receipt of dividends and other distributions from our subsidiaries and proceeds on the disposition of such subsidiaries, as well as investment income and proceeds on the sale or maturity of our investments.
On February 28, 2001, we acquired one of our investee companies, American Independent Insurance Company. American Independent underwrites private passenger automobile liability and physical damage insurance primarily in the Commonwealth of Pennsylvania. See "Business--Acquisitions" above. On an ongoing basis we will determine how much of the insurance premium underwritten by American Independent will be retained by us and how much commission income we will capture through the purchase of reinsurance.
On March 23, 2001, we entered into a reorganization agreement for the acquisition of all of the remaining ownership interests in Altus Holdings, Ltd., which provides insurance and alternative risk transfer services through rent-a-captive and other facilities. See "Business--Acquisitions" above. The Altus group includes First American Insurance Company, an admitted insurer in 49 states with an A.M. Best rating of "A-."
At December 31, 2000, our consolidated shareholders' equity totaled $275.3 million, or $21.66 per share on a diluted basis, based on 12,709,579 common shares outstanding, compared to our consolidated shareholders' equity at December 31, 1999 of $346.5 million, or $20.28 per share on a diluted basis, based on 17,087,970 shares outstanding. The decrease in consolidated shareholders' equity primarily resulted from our share repurchase on March 2, 2000 from XL Capital of all of the 4,755,000 common shares held by it for a repurchase price of $59.2 million, or $12.45 per share. We paid XL the consideration for the repurchase with our ownership interests in LARC Holdings and Annuity & Life Re. XL paid us in cash the $3.6 million difference between the repurchase price and the value of such investments. See note 13 of the notes accompanying our consolidated financial statements.
At December 31, 2000, consolidated cash and invested assets totaled approximately $279.1 million, consisting of $108.9 million of cash and short-term investments, $38.5 million of publicly traded fixed maturity investments, $21.0 million of fixed maturities held in escrow, $51.3 million of publicly traded equity securities, and $59.4 million of privately held securities.
Investments included in our private portfolio include securities issued by privately held companies that are generally restricted as to resale or are otherwise illiquid and do not have readily ascertainable market values. The risk of investing in such securities is generally greater than the risk of investing in securities of widely held, publicly traded companies. Lack of a secondary market and resale restrictions may result in an inability by us to sell a security at a price that would otherwise be obtainable if such restrictions did not exist and may substantially delay the sale of a security we seek to sell.
See note 4 under the caption "Investment Information" of the notes accompanying our consolidated financial statements for certain information regarding our publicly traded and privately held securities and their carrying values, and commitments made by us relating to our privately held securities.
On February 28, 2001, we completed a reorganization transaction pursuant to which we acquired all of the common stock of American Independent Insurance Holding Company, one of our investee companies. On March 23, 2001, we entered into a reorganization agreement for the acquisition of the remaining ownership interests in Altus Holdings, Ltd., another of our investee companies. See "Business--Acquisitions" above and note 15 of the notes accompanying our consolidated financial statements.
At December 31, 2000, approximately 100% of our fixed maturity and short-term investments were rated investment grade by Moody's or Standard & Poor's and had an average quality rating of AA and an average duration of approximately 1.3 years. In November 2000, we liquidated our high yield portfolio in connection
with our reorganization transaction. In January 2001, we began to reinvest approximately $35 million of cash in high yield fixed maturity investments. At March 15, 2001, we had approximately $33 million of such funds invested in high yield investments, with an average quality rating of BB- and an average duration of 4.4 years.
We have not invested in derivative financial instruments such as futures, forward contracts, swaps, or options or other financial instruments with similar characteristics such as interest rate caps or floors and fixed-rate loan commitments. Our portfolio includes market sensitive instruments, such as mortgage-backed securities, which are subject to prepayment risk and changes in market value in connection with changes in interest rates. Our investments in mortgage-backed securities, which amounted to approximately $5.5 million at December 31, 2000, or 2% of cash and invested assets, are classified as available for sale and are not held for trading purposes.
Our investment yields at amortized cost were as follows for the periods set forth below:
In 2000, net realized gains include $11.0 million of pre-tax losses, or $8.7 million after-tax, recorded during the 2000 fourth quarter resulting from the restructuring of our investment portfolio in connection with our redomestication to Bermuda on November 8, 2000. In addition, we recorded a pre-tax realized loss of $1.7 million, or $1.1 million, after-tax, that adjusted the cost basis on two publicly traded equity securities held in our portfolio to a new cost basis to recognize an "other than temporary" decline in their respective market values. While the effect of recording this loss of $1.7 million reduced net income, such loss had no impact on our shareholders' equity because such investments are carried in the consolidated balance sheet at market value with unrealized losses, net of tax, reported as a separate component of shareholders' equity.
For 2000, the change in after-tax net unrealized appreciation of investments of $8.8 million reflects the following (in millions):
Under current Bermuda law, ACGL is not obligated to pay any taxes in Bermuda based upon income or capital gains. We have received a written undertaking from the Minister of Finance in Bermuda under the Exempted Undertakings Tax Protection Act 1966 that, in the event that any legislation is enacted in Bermuda imposing any tax computed on profits, income, gain or appreciation on any capital asset, or any tax in the nature of estate duty or inheritance tax, such tax will not be applicable to us or our operations until March 28, 2016. This undertaking does not, however, prevent the imposition of taxes on any person ordinarily resident in Bermuda or any company in respect of its ownership of real property or leasehold interests in Bermuda.
The net deferred income tax asset at December 31, 2000 was $8.2 million, compared with $7.8 million at December 31, 1999. As of December 31, 2000, Arch-U.S. has a valuation allowance of $5.7 million that adjusts the net deferred income tax asset to its estimated realizable value of $8.2 million. At December 31, 1999, Arch-U.S. did not have a valuation allowance because it believed at that time that its entire deferred tax asset was realizable due to its ability to generate future taxable income.
As a result of its net operating losses in 2000 and 1999, Arch-U.S. has net operating loss carryforwards totaling $35.6 million at December 31, 2000. Such net operating losses are currently available to offset future taxable income of Arch-U.S. with the following expiration dates: $18.3 million expiring in 2019 and $17.3 million expiring in 2020.
The repurchase of our common shares held by XL Capital resulted in a 27.8% change in ownership by 5% shareholders. If, in the ensuing three years, there is more than a 22.2% additional change in ownership by 5% shareholders, an "ownership change" will have taken place for federal income tax purposes. If such ownership change occurs, the amount of loss carryforwards that can be used in any subsequent year may be severely limited and could be eliminated in certain circumstances.
See notes 10 and 13 of the notes accompanying our consolidated financial statements.
With respect to Arch Re's divested reinsurance operations, net premiums written for the years ended December 31, 2000, 1999 and 1998 were as follows:
Arch Re's net premiums written increased 31% to $306.7 million in 1999 from $234.7 million in 1998. Premium growth resulted from two key strategies, the integration of investment with reinsurance and the diversification into "specialty" classes of business, which for purposes of this discussion consist of accident & health, aviation & space, marine and surety & fidelity.
Net premiums written in 1999 included approximately $26 million related to a group of property reinsurance treaties that expired in 1999 covering crop hail business underwritten on behalf of a start-up entity formed by Trident II, L.P. This business was protected by extensive aggregate excess of loss retrocession and generated a profit based upon underwriting results.
Arch Re's ceded premiums were $19.7 million in 2000, $80.1 million in 1999, and $25.8 million in 1998. Such ceded premiums primarily related to Arch Re's property, multi-line, marine, aviation and space reinsurance business, for which the Company sought to reduce Arch Re's exposure to large and catastrophic losses. In 2000 and 1999, the Company purchased additional retrocessional protection to reduce Arch Re's exposures to both space and aviation risks, and to earthquake, wind and other property catastrophe perils. See "--Results of Operations--Space & Aviation Business Relating to Divested Reinsurance Operations" and note 8 of the notes accompanying our consolidated financial statements.
The statutory combined ratio is one traditional method of measuring the underwriting performance of a property/casualty insurer. This ratio, which is based upon statutory accounting principles (which differ from generally accepted accounting principles in several respects), reflects underwriting experience, but does not reflect income from investments. A statutory combined ratio under 100% indicates underwriting profitability, while a combined ratio exceeding 100% indicates an underwriting loss.
With respect to Arch Re's reinsurance operations, which were divested May 5, 2000, set forth below are Arch Re's statutory combined ratios for the years ended December 31, 2000, 1999 and 1998:
With respect to Arch Re's reinsurance operations, which were divested May 5, 2000, after-tax underwriting losses for the years ended December 31, 2000, 1999 and 1998 were as follows:
Arch Re's 2000 combined ratio was adversely effected by underwriting results from our property, multi-line and aviation & space business. Arch Re's 1999 and 1998 statutory combined ratios were adversely affected by underwriting results from business written by a managing general agency and our space and aviation classes of business.
During 1999 and 1998, Arch Re recorded after-tax underwriting losses of $16.5 million, or $0.96 per share, and $6.5 million, or $0.38 per share, respectively, from reinsurance on casualty and multi-line business produced by the managing underwriting agency. Such business increased the combined ratio by 7.7 points and 4.1 points in 1999 and 1998, respectively. Arch Re also recorded related after-tax investment losses of $1.3 million, or $0.07 per share, and $862,000, or $0.03 per share, in net realized investment losses in 1999 and 1998, respectively. Arch Re discontinued its underwriting relationship with the managing underwriting agency in 1999.
Net reserves for claims and claims expenses for this business approximated $32.3 million at May 5, 2000, the closing date of the sale of Arch Re's reinsurance operations. See "--Results of Operations--Reserve for Contingent Loss of Escrowed Assets," "Business--Significant 2000 Developments--Sale of Reinsurance Operations" and note 2 of the notes accompanying our consolidated financial statements for a discussion of a $20 million escrow fund relating to such reserves established in connection with the sale of our reinsurance operations to Folksamerica.
During 2000, 1999 and 1998, Arch Re recorded after-tax underwriting losses of $6.1 million, or $0.46 per share, $19.7 million, or $1.15 per share, and $7.8 million, or $0.46 per share, respectively, for its space and aviation lines of business. The effect on the combined ratio in 2000 from such losses is meaningless because net premiums written were negative due to ceded premiums written. Underwriting losses increased the combined ratio by 8.3 and 4.9 points in 1999 and 1998, respectively. During 1999, Arch Re discontinued both lines of business; however, exposures continued post-1999 from multi-year treaties and treaties in run-off.
Included in the 1999 after-tax underwriting loss for aviation business are incurred losses for the 1998 Swiss Air and Korean Air crashes and certain 1999 crashes, including the Egypt Air, American Airlines, Korean Air and China Air crashes. The additional loss recorded in 1999 for the Swiss Air crash was based on a reallocation of the $642 million expected industry loss between the plane manufacturer and Swiss Air. This reallocation adversely affected Arch Re's gross loss. The gross loss associated with the Swiss Air crash reported as of December 31, 1998 had exhausted Arch Re's retrocessional protections applicable to this occurrence. Therefore, none of such additional loss reported was ceded to retrocessionaires.
All other classes of business also contributed to the 2000 and 1999 underwriting losses (except for multi-line in 1999), with the largest contribution for 1999 from property business. The after-tax underwriting loss for 1999 property business approximated $4.9 million, which included after-tax losses of $4.3 million for two large catastrophes in 1999 (Rouge steel plant in Dearborn, Michigan, and French storm losses).
Estimates of prior accident year claims were reduced by approximately $2.8 million in 1998 primarily due to favorable claim development in the property and multi-line classes of business.
Other operating expenses were $8.0 million in 2000, compared to $14.8 million and $16.5 million for the years ended December 31, 1999 and 1998, respectively.
For 2000, our operating expenses decreased 46% primarily reflecting reduced operating costs resulting from the sale of Arch Re's reinsurance operations on May 5, 2000.
For 1999, our statutory operating expense ratio declined to 4.7%, compared with 6.8% for 1998. The decline in the operating expense ratio was due to a decrease in other operating expenses and an increase in Arch Re's net premiums written from the comparable prior year period. In addition, commencing in 1999, we allocated certain compensation and other operating expenses related to investment activities in the amount of $2.1 million to net investment income based on internal time studies. Such allocations were not made in prior periods. Due to such allocations, the 1999 statutory operating expense ratio improved by approximately one point and net investment income was reduced by approximately $0.08 per share, with no overall effect on operating results. On a pro-forma basis, the statutory operating expense ratio for 1998 would have been 5.8%.
For the period January 1, 2000 through the sale of Arch Re's reinsurance operations on May 5, 2000, and for the years ended December 31, 1999 and 1998, the company recorded pre-tax foreign exchange gains and losses separately from statutory underwriting results and such gains and losses were therefore excluded from the statutory combined ratios. Unhedged monetary assets and liabilities prior to May 5, 2000 were translated at the exchange rate in effect at the balance sheet date, with the resulting foreign exchange gains or losses recognized in income. For the period January 1, 2000 through May 5, 2000, and for the years ended December 31, 1999 and 1998, pre-tax foreign exchange gains and (losses) were ($1,159,000), $198,000 and $443,000, respectively. At December 31, 2000, all of our assets and liabilities were denominated in U.S. dollars.
In accordance with the SEC's Financial Reporting Release No. 48, the following analysis presents hypothetical losses in cash flows, earnings and fair values of market sensitive instruments which are held by us as of December 31, 2000 and are sensitive to changes in interest rates and equity security prices. This risk management discussion and the estimated amounts generated from the following sensitivity analysis represent forward-looking statements of market risk assuming certain adverse market conditions occur. Actual results in the future may differ materially from these projected results due to actual developments in the global financial markets. The analysis methods used by us to assess and mitigate risk should not be considered projections of future events of losses.
We are exposed to equity price risks on the public and private equity securities included in our investment portfolio. All of our publicly traded equity securities and privately held securities were issued by insurance and reinsurance companies or companies providing services to the insurance industry. We typically do not attempt to reduce or eliminate our market exposure on these securities. Investments included in our private portfolio include securities issued by privately held companies that are generally restricted as to resale or are otherwise illiquid and do not have readily ascertainable market values. Investments in privately held securities issued by privately held companies may include both equity securities and securities convertible into, or exercisable for, equity securities (some of which may have fixed maturities).
Our publicly traded and privately held equity securities at December 31, 2000, which are carried at a fair value of $51.3 million and $59.4 million, respectively, have exposure to price risk. The estimated potential losses in fair value for our publicly traded and privately held equity portfolios resulting from a hypothetical 10% decrease in quoted market prices, dealer quotes or fair value are $5.1 million and $5.9 million, respectively.
In March 1998, the NAIC adopted the codification of statutory accounting principles project that will generally be applied to all insurance and reinsurance company financial statements filed with insurance regulatory authorities as early as the statutory filings made in 2001. Although the codification is not expected to materially affect many existing statutory accounting practices presently followed by most insurers and reinsurers, there are several accounting practices that may be changed. As of December 31, 2000, we have estimated that, on a consolidated basis, there will be no effect on surplus as a result of the adoption of the codification.