Year Ended December 31, 2000 Compared to Year Ended December 31 1999
Partially offsetting these reductions in net earnings were: (1) an increase in net investment income due to the combination of higher average investment yields (as a result of the increasing U.S. interest rate environment throughout most of 2000) and repositioning of the investment portfolio to include a higher proportion of fixed maturity securities and (2) tax benefits attributable to a step-up in the tax basis of certain assets following the conversion of a corporate subsidiary to a partnership for German tax purposes.
Net earnings decreased $59 million or 8% in 1999, including an increase in after-tax net realized gains on investments of $176 million. Excluding after-tax net realized gains on investments, net earnings decreased $235 million or 46% in 1999. This decrease was primarily attributable to increased property and casualty-related losses related to the frequency and severity of large loss events occurring in 1999 as compared to 1998 and, to a lesser extent, adverse development on prior year recorded losses. Large loss events are individual events that, after specific reinsurance recoveries and related premium adjustments, affect operations by $2 million or more, and include losses from earthquakes, aviation or railroad accidents, fire damage, and weather-related damage from hurricanes, tornadoes, wind and ice. Large loss events occurring in 1999 resulted in recorded losses of approximately $510 million, as compared to approximately $150 million in 1998. A portion of the 1999 losses was recovered under aggregate excess retrocession coverages obtained in the ordinary course of business. The increase in property and casualty-related losses was partially offset by a $166 million increase in net investment income, primarily due to growth in the investment portfolio as a result of acquisitions, and a $134 million increase in other revenues, primarily due to acquisitions, equity-method investments and a gain on disposition of the Company's reinsurance brokerage subsidiary. An increase in underwriting and operating expenses associated with acquisitions and continued competitive market conditions also contributed to the deterioration in underwriting results.
The relatively high combined ratios in 2000 and 1999 primarily reflect the effects of continued insufficient pricing within the overall property and casualty insurance/reinsurance industry and adverse development on prior year recorded losses. The 1999 combined ratio was also adversely impacted by a heightened frequency and severity of large loss events occurring in that year.
Earnings before income taxes, excluding net realized gains on investments, increased $105 million in 2000, primarily attributable to the decrease in the combined ratio and the increase in net investment income discussed above. Earnings before income taxes, excluding net realized gains on investments, decreased $273 million in 1999, primarily attributable to the significant increase in the combined ratio, partially offset by the increase in net investment income discussed above.
Earnings before income taxes decreased $6 million or 2% in 2000, including a $15 million increase in net realized gains on investments. Excluding net realized gains on investments, earnings before income taxes decreased $21 million or 13% in 2000, primarily attributable to an increase in claims experience. Earnings before income taxes increased $87 million or 55% in 1999, including a $48 million increase in net realized gains on investments. Excluding net realized gains on investments, earnings before income taxes increased $39 million or 32% in 1999, primarily attributable to an increase in net investment income, primarily due to continued growth in the investment portfolios, and fees generated from investment-related life reinsurance products and financial reinsurance transactions.
Cash flows from financing activities increased $520 million in 2000, primarily attributable to the following factors: (1) an increase in short-term borrowings, (2) a reduction in dividends paid on common stock and (3) an increase in contract deposit liabilities resulting from growth in financial reinsurance business volumes. The $691 million of proceeds from long-term borrowings in 2000 were substantially all used to repay outstanding borrowings under an interim loan agreement with GE Capital Corporation used to fund the Company's 1998 acquisition of Medical Protective. Cash flows from financing activities decreased $733 million in 1999, primarily attributable to the large amount of 1998 proceeds from short-term borrowings associated with the acquisitions of Medical Protective and GE Re and the change in contract deposit liabilities resulting from the 1998 commutation of a significant financial reinsurance treaty. The $395 million of proceeds from long-term borrowings in 1999 were used largely to repay short-term borrowings made in 1998 under the Company's revolving credit agreement with GE Capital Services.
The Company has a one-year $600 million revolving credit agreement with GE Capital Services which enables the Company to borrow from GE Capital Services at an interest rate per annum equal to GE Capital Services' cost of funds for a one year period. The agreement is automatically extended for successive terms of one year each unless terminated in accordance with terms of the agreement.
The Company uses various financial instruments, such as cross currency swaps, options and currency forwards, principally to manage currency risks. The Company is exclusively an end-user of these instruments, which are commonly referred to as derivatives. The Company does not engage in trading, market-making or other speculative activities in the derivatives markets. Management requires that derivative financial instruments relate to specific asset, liability or equity transactions or to currency exposures. More detailed information about these financial instruments, as well as the strategies and policies for their use, is provided in Notes 2 and 14 to the consolidated financial statements.
The U.S. Securities and Exchange Commission requires that registrants provide information about potential effects of changes in interest rates and currency exchange. Although the rules offer alternatives for presenting this information, none of the alternatives is without limitations. The following discussion is based on so-called "shock-tests," which model effects of interest rate and currency shifts on the reporting company. Shock tests, while probably the most meaningful analysis permitted, are constrained by several factors, including the necessity to conduct the analysis based on a single point in time and by their inability to include the complex market reactions that normally would arise from the market shifts modeled. While the following results of shock tests for interest rates and currencies may have some limited use as benchmarks, they should not be viewed as forecasts.
One means of assessing exposure to changes in currency exchange rates is to model effects on reported earnings using a sensitivity analysis. Year-end 2000 consolidated currency exposures, including financial instruments designated and effective as hedges, were analyzed to identify Company assets and liabilities denominated in other than their relevant functional currency. Net unhedged exposures in each currency were then remeasured assuming a 10 percent decrease (substantially greater decreases for hyperinflationary currencies) in currency exchange rates compared with the U.S. dollar. Under this model, it is estimated that, all else constant, such a decrease would reduce the 2001 net earnings of the Company based on year-end 2000 positions by an insignificant amount.
The Financial Accounting Standards Board ("FASB") has issued, then subsequently amended, Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities, effective for the Company on January 1, 2001. Upon adoption, all derivative instruments (including certain derivative instruments embedded in other contracts) will be recognized in the balance sheet at their fair values; changes in such fair values must be recognized immediately in earnings unless specific hedging criteria are met. Effects of qualifying changes in fair value will be recorded in equity pending recognition in earnings as offsets to the related earnings effects of the hedged items. Management estimates that, at January 1, 2001, the effects on its consolidated financial statements of adopting SFAS No. 133, as amended, will be a one-time reduction of net earnings of less than $20 million. The precise transition effect is uncertain because the accounting for certain derivatives and hedging relationships in accordance with SFAS No. 133 is subject to further interpretation by the FASB.