(2) Income from continuing operations before interest and income tax expense and dividends on Capital Securities of Delphi Funding L.L.C.
(3) Reflects the issuance of and the payment of dividends on $100.0 million of Capital Securities by Delphi Funding L.L.C. (the "Capital Securities"). See Note J to the Consolidated Financial Statements.
(4) The Company discontinued its long-term care business in 1996 and recorded a one-time after-tax charge of $5.8 million in 1996 attributable to this discontinuance. After-tax operating losses on this business were $0.8 million, $2.3 million and $0.1 million in 1996, 1995 and 1994, respectively.
(9) The debt to total capitalization ratio is calculated by dividing long-term debt by the sum of the Company's long-term debt, Capital Securities and shareholders' equity.
Insurance Premiums and Fee Income. Insurance premiums in 1998 were $418.4 million as compared to $358.4 million in 1997, an increase of 17%. This increase was primarily attributable to the Company's group employee benefits segment and reflects strong production of new business, normal growth in employment and salary levels for the Company's existing customer base and expansion within the alternative risk transfer market. A decrease in excess workers' compensation premiums from prior year levels as a result of a continued weak pricing environment in this market sector has not had a material impact on underwriting results due to corresponding decreases in benefits. Fee income was $31.5 million ($26.3 million in the fourth quarter) in 1998 as compared to $2.5 million in 1997. This increase was due to the inclusion of fee income of $28.8 million from the Company's reinsurance underwriting management and integrated disability and absence management subsidiaries, which were acquired in 1998. Deposits from the Company's SPDA products, including the Company's MVA annuity product, were $46.0 million in 1998 as compared to $55.5 million in 1997. Deposits for these products, which are long-term in nature, are not recorded as premiums; instead, the deposits are recorded as a liability. The decrease in deposits was principally attributable to a decline in the demand for fixed annuity products due to the low interest rate environment.
The Company's future ability to generate fee income at the level reflected in the fourth quarter of 1998 is to a significant extent dependent on the future reinsurance premiums generated by the Pools Unicover manages. Pending the resolution of certain existing disputes relating to the retrocessional coverage for the Pools managed by Unicover, which coverage by its contractual terms extends to December 2000, Unicover has at present ceased accepting new reinsurance business on behalf of the Pools; moreover, a number of Unicover pool and facility members have recently terminated participation in the Pools as to new business. In addition, while substantial future fee income is contractually associated with anticipated premiums on reinsurance business previously placed by Unicover on behalf of the Pools, uncertainties, including the retrocessional coverage disputes, exist which may adversely impact the practical ability to realize such premiums, and therefore, such fee income. For all of these reasons, which resulted from developments occurring in the first quarter of 1999, no assurances can be given concerning future levels of the Company's fee income.
Benefits and Expenses. Policyholder benefits and expenses were $471.5 million in 1998 as compared to $404.9 million in 1997, an increase of 16%. Benefits and expenses for the Company's group employee benefit products increased by $60.6 million in 1998 primarily due to growth in this segment. The combined ratio (loss ratio plus expense ratio) for group employee benefit products was 96.5% in 1998 and 95.9% in 1997. The increase in benefits and expenses also includes an $11.9 million increase in other operating expenses primarily attributable to the Company's reinsurance underwriting management and disability and absence management subsidiaries, which were acquired in 1998. Benefits and interest credited on asset accumulation products decreased by $4.1 million in 1998 principally due to a decrease in average funds under management from $670.1 million in 1997 to $628.7 million in 1998. In addition, the weighted average annual crediting rate on asset accumulation products decreased from 5.3% in 1997 to 5.2% in 1998.
Income Taxes. Income tax expense was $44.7 million in 1998 as compared to $38.2 million in 1997. The Company's effective tax rate was 32.4% in both 1998 and 1997.
Insurance Premiums and Fee Income. Insurance premiums in 1997 were $358.4 million as compared to $333.0 million in 1996, an increase of 8%. Premiums from the Company's group employee benefits segment, excluding excess workers' compensation insurance, increased by $16.2 million primarily due to the impact of certain price increases, growth and development of the Company's distribution system and normal growth in employment and salary levels for the Company's existing customer base. Premiums from the Company's excess workers' compensation insurance product, which was acquired in March 1996 and included in the Company's results from the date of the acquisition, totaled $64.5 million in 1997 as compared to $56.2 million in 1996. Excess workers' compensation insurance premiums have decreased from full-year 1996 levels primarily due to state mandated reductions in workers' compensation premium rates and increased competition. The Company does not expect this reduction in premiums to have a material impact on the underwriting results for this product as decreased workers' compensation benefit levels, also mandated by the states, are expected to offset the decline in premiums. Deposits from the Company's SPDA products, including the Company's MVA annuity product, were $55.5 million in 1997 as compared to $57.5 million in 1996. Deposits for these products, which are long-term in nature, are not recorded as premiums; instead, the deposits are recorded as a liability.
Benefits and Expenses. Policyholder benefits and expenses were $404.9 million in 1997 as compared to $390.0 million in 1996, an increase of 4%. During 1997, benefits and expenses for group employee benefit products increased by $20.8 million as compared to 1996, primarily due to growth in this segment. Also contributing to the increase was the inclusion of the Company's excess workers' compensation insurance product, which was acquired in March 1996, for the full year of 1997. The combined ratio (loss ratio plus expense ratio) for group employee benefit products was 95.9% and 96.7% for 1997 and 1996, respectively. While amortization of cost of business acquired related to asset accumulation products was accelerated by $4.8 million during 1996 due to better than expected investment results, there was no net acceleration or deceleration during 1997. The weighted average annual crediting rate on asset accumulation products for 1997 and 1996 was 5.3% and 5.2%, respectively.
Interest Expense. Interest expense in 1997 was $15.0 million as compared to $18.3 million in 1996. This decrease is primarily due to the repayment of $50.0 million of borrowings under the Credit Agreement with a portion of the proceeds from the issuance of the Capital Securities, partially offset by the inclusion in 1997 of a full year of interest expense on the $45.0 million of 8.5% senior secured notes due 2003 (the "SIG Senior Notes") assumed in connection with the acquisition of SNCC in 1996. In addition, the 1996 period includes interest paid in connection with the settlement of prior-year federal income taxes.
Income Taxes. Income tax expense in 1997 was $38.2 million as compared to $27.5 million in 1996. The Company's effective tax rate decreased from 33.8% in 1996 to 32.4% in 1997 primarily due to tax-exempt investment income.
General. The Company had approximately $223.8 million of financial resources available at the holding company level at December 31, 1998, which was primarily comprised of investments in the common stock of its investment subsidiaries and fixed maturity securities. The assets of these investment subsidiaries are primarily invested in fixed maturity securities, balances with independent investment managers and marketable securities. Substantially all of the amounts invested with independent investment managers are withdrawable at least annually, subject to applicable notice requirements. A shelf registration is also in effect under which up to $49.2 million in securities may be issued by the Company.
The Company's current liquidity needs, in addition to funding operating expenses, include distributions on the Capital Securities and principal and interest payments on outstanding borrowings under the Credit Agreement, the Senior Notes, the SIG Senior Notes and the $5.7 million of 8% subordinated notes due 2003 (the "Subordinated Notes"). The junior subordinated debentures underlying the Capital Securities are not redeemable prior to March 25, 2007, and, at the Company's current level of borrowings, no principal repayments are required under the Credit Agreement until October 1, 2001. The Senior Notes mature in their entirety on October 1, 2003 and are not subject to any sinking fund requirements nor are they redeemable prior to maturity. The SIG Senior Notes amortize in $9.0 million annual installments beginning in May 1999, and the Subordinated Notes mature in their entirety in June 2003. See Note E to the Consolidated Financial Statements.
Cash Flows. During 1998, operating activities increased cash and cash equivalents by $42.5 million, excluding the one-time effect of the cession of $101.5 million of group employee benefit product reserves to Oracle Re (see Note O to the Consolidated Financial Statements). In addition to the Oracle Re transaction, operating cash flows decreased as compared to 1997 primarily due to an increase in federal income taxes paid. This increase was principally due to timing differences in recognizing income from investing activities. Cash flows from purchases and sales of investments in 1998 reflect the repositioning of a portion of the Company's portfolio into selected categories of fixed maturity securities to take advantage of opportunities in the marketplace to enhance investment returns while maintaining the Company's investment objectives of safety and liquidity. There were no significant changes in the credit quality of the Company's investment portfolio as a result of this investment activity. Cash provided by financing activities was primarily used to fund investment related activities during the 1998 period.
Investments. The Company's overall investment strategy to achieve its objectives of safety and liquidity, while seeking the best available return, focuses on, among other things, managing the durations of the Company's interest-sensitive assets and liabilities and minimizing the Company's exposure to fluctuations in interest rates. The Company's investment portfolio primarily consists of investments in fixed maturity securities, cash and short-term investments. The weighted average credit rating of the Company's fixed maturity portfolio as rated by Standard & Poor's Corporation was "AA" at December 31, 1998. While the investment grade rating of the Company's fixed maturity portfolio addresses credit risk, it does not address other risks, such as prepayment and extension risks, which are discussed below.
Mortgage-backed securities subject the Company to a degree of interest rate risk, including prepayment and extension risk, which is generally a function of the sensitivity of each security's underlying collateral to prepayments under varying interest rate environments and the repayment priority of the securities in the particular securitization structure. The Company seeks to limit the extent of this risk by emphasizing the more predictable payment classes and securities with stable collateral.
The Company maintains an investment program in which securities were purchased using advances from the FHLB. The Company has utilized this program to manage the duration of its liabilities and to earn spread income, which is the difference between the financing cost and the earnings from the securities purchased with those funds. During 1998, $125.0 million of advances from the FHLB matured and was repaid. The remaining outstanding advances of $75.0 million do not begin to mature until 2003. In addition, the Company utilizes reverse repurchase agreements and futures and option contracts from time to time in connection with its investment strategy. These transactions require the Company to maintain securities or cash on deposit with the applicable counterparty as collateral. As the market value of the collateral or futures and options contracts changes, the Company may be required to deposit additional collateral or be entitled to have a portion of the collateral returned to it. The Company also maintains a securities lending program under which certain securities from its portfolio are loaned to other institutions for short periods of time. The collateral received for securities loaned is recorded at the fair value of the collateral, which is generally in an amount in excess of the market value of the securities loaned. The Company monitors the market value of the securities loaned and obtains additional collateral as necessary.
The year 2000 issue relates to whether computer systems will properly recognize date-sensitive information when the year changes to 2000. This inability to recognize the year 2000 may cause systems to process critical financial and operational information incorrectly. This, in turn, could cause disruptions of normal business operations, including the inability to process claims, bill and collect premium, perform policy administration and manage investment activities. The Company has a corporate-wide program underway to address the year 2000 issue, as it relates to its own computer systems, as well as to instances in which computer systems of third parties may have a significant impact on the Company's operations, such as those of suppliers, business partners, customers, facilities and telecommunications.
The information required by Item 8 is included in this Form 10-K beginning on page 26 of this Form 10-K.