A variety of factors accounted for the 34.4% growth in net premiums earned, the principal factor being increases in the Company's core and new program businesses in the general liability, surety, workers' compensation, and commercial multi-peril lines of business. Net premiums earned also grew due to the acquisitions of Lyndon in May 1997 and Acceleration in January 1998, which provide credit-related products, Western in December 1997, which offers medical malpractice coverage and Environmental Commercial Insurance Agency, Inc. ("ECI") in December 1997 which produces policies for environmental risks in the general liability line. This increase was partially offset by a decrease in medical malpractice business, commercial earthquake business, the planned decrease in a general liability program for apartment owners and to increased premiums ceded under the aggregate excess of loss reinsurance treaty.
Medical malpractice net premiums earned in the Health Care Division decreased, primarily due to the sale of the Florida physicians business in December 1997. This decrease was partially offset by the increase in business from the acquisition of Western, and to increased writings for physicians, dentists and psychiatrists due to geographic expansion.
The growth in the surety line was primarily attributable to expanded writings of license and permit bonds, service contract bonds, customs bonds, lost instrument bonds, self insured workers' compensation bonds, landfill bonds and subdivision bonds, partially offset by a decrease in the contract bond business for small contractors due to increased price competition.
Net premiums earned for the workers' compensation line increased due to increased writings in the Alternative Risk Division, primarily in the captive and rent-a-captive programs, and to business acquired in the Western acquisition and written in the Health Care Division.
Net premiums earned in the commercial earthquake line written in the Alternative Risk Division decreased primarily due to the planned decrease in this program.
Net premiums earned in the other lines of business increased, primarily due to an increase in volume written in the Alternative Risk, Specialty Programs, and Health Care Divisions, primarily in the group accident and health, ocean marine, international property and commercial auto liability lines of business.
Total expenses increased 74.4%, compared to the 34.4% increase in net premiums earned. Losses and LAE increased 88.8% as a result of a 66.5% increase in losses and a 141.5% increase in LAE. Amortization of policy acquisition costs, underwriting and other expenses increased 55.7% as a result of a 46.9% increase in amortization of policy acquisition costs and a 70% increase in underwriting and other expenses.
Amortization of policy acquisition costs, underwriting and other expenses ("Expenses") increased in the Health Care Division primarily due to the acquisition of Western and to increases in staffing, and marketing expenses. Expenses in the Surety Division increased due to increased policy acquisition costs and to the move of this division to Nashville early in the fourth quarter of 1998. The increases in Expenses in the Alternative Risk and Environmental, Excess and Surplus Lines Divisions were in direct proportion to the increase in net premiums earned. Expenses in the Specialty Programs Division increased due to the costs associated with the opening of a new start-up operation and to increased staffing and marketing costs. Expenses in the Personal and Credit-Related Division increased due to the acquisition of Acceleration in January 1998, partially offset by the recognition of $8.3 million of amortization of the excess of net assets over the purchase price associated with the Lyndon acquisition.
The increase in interest expense was primarily the result of additional borrowings under the line of credit during 1998.
A variety of factors accounted for the 37.9% growth in net premiums earned, the principal factor being increases in the Company's core and new program businesses in the general liability, surety, medical malpractice and commercial multi-peril lines of business. Net premiums earned also grew due to the acquisitions of Lyndon, which writes personal lines and credit-related products, United Capitol, which provides general liability coverage for environmental and artisan contractors and, to a lesser degree Western, which offers medical malpractice coverage. This increase was partially offset by a decrease in workers' compensation, particularly the cotton gin program and social service programs that the Company discontinued during 1996 due to price competition.
The increase in general liability net premiums earned was primarily attributable to increase business written in the Environmental, Excess and Surplus Lines Division, primarily due to the acquisition of United Capitol, growth in programs in the Specialty Programs Divisions, primarily in the artisan's contractor and demolition contractor programs, and to growth in the excess employers' liability program in the Alternative Risk Division. These increases were partially offset by decreases in the specialty programs division, primarily due competition in the crane operators' liability program and to decreased writings for umbrella coverages.
Medical malpractice net premiums earned in the Health Care Division increased 4.1%, primarily attributable to an increase in the number of physicians insured in the programs for psychiatrists and alternative risks, geographical expansion in Ohio, Texas, Michigan, and Illinois and growth in the dental program endorsed by the Academy of General Dentistry and, to a lesser degree, the acquisition of Western in December 1997. These increases were partially offset by a decrease in Florida business due to rate increases, the sale of the Florida medical malpractice business and from the reclassification of certain medical malpractice business to the general liability line.
Net premiums earned in the commercial earthquake line written in the Alternative Risk Division decreased 8.6%, primarily due to the planned decrease in this business.
Net premiums earned in the other lines of business increased, primarily due to an increase in volume written in the Alternative Risk, Specialty Programs, and Health Care Division, primarily in the group accident and health, ocean marine, international property and commercial auto liability lines.
Total expenses increased 53.6%, compared to the 37.9% increase in net premiums earned. Losses and LAE increased at a 50.4% rate as a result of a 70.0% increase in losses and a 18.1 % increase in LAE. Amortization of policy acquisition costs, underwriting and other expenses increased 53.2% rate as a result of a 45.2% increase in amortization of policy acquisition costs and a 68.1% increase in underwriting and other expenses.
Amortization and policy acquisition costs, underwriting and other expenses ("Expenses") increased in the Health Care Division, primarily due to the acquisition of Western in December 1997 and to increased staffing and marketing expenses related to expansion, and salary increases. Expenses in the Personal and Credit-Related Division increased due to the acquisition of Lyndon in 1997 and Regency in 1996, partially offset by the recognition of $5.8 million of the amortization of the excess of net assets over the purchase price associated with the Lyndon acquisition. Expenses in the Environmental, Excess and Surplus Lines Division increased primarily due to the acquisition of United Capitol in 1996 and to increased staffing and marketing expenses related to expansion. Expenses in the Surety, Specialty Programs and Alternative Risk Divisions increased due to increased staffing and marketing expenses related to expansion, and salary increases.
The decrease in interest expense was primarily the result of the repayment and termination of the line of credit in the fourth quarter of 1996, partially offset by the interest expense associated with the draw-down of $62 million from a revolving credit facility that the Company obtained on June 3, 1997.
The Company invests primarily in fixed income securities with the objective of maximizing after-tax investment income and total investment returns within approved investment guidelines. The core investment portfolio contains fixed maturity securities which are rated investment grade. At December 31, 1998, the Company held investment grade rated securities with a carrying value of $1.17 billion, representing 97.6% of total fixed maturity investments. Fixed maturity investments with credit ratings below investment grade, which are maintained as part of the alternative iInvestment portfolio, totaled $28.6 million at December 31, 1998 and represented the 2.4% balance of the total fixed maturity investments.
At December 31, 1998 and 1997, the Company's fixed maturity investments included mortgage-backed securities of $391.3 million and $368.6 million, respectively, which are subject to risks associated with variable prepayments of the underlying mortgage loans that differ from typical fixed maturities. Securities that have an amortized cost greater than par value that are backed by mortgages that prepay faster than expected will incur a reduction in yield, while securities that have an amortized cost less than par value that are backed by mortgages that prepay faster than expected will generate an increase in yield. The degree to which a security is susceptible to either gains or losses is influenced by the difference between amortized cost and par value, the relative sensitivity of the underlying mortgages backing the assets to prepayment risk and the repayment priority of the securities in the overall structure of a securitization.
The alternative investment portfolio includes investments in limited partnerships with carrying values of $27.3 million and $17.8 million at December 31, 1998 and 1997, respectively. The partnerships have varying investment strategies and these investments were made by the Company with the objective of long-term capital appreciation. The investments generally contain lock-up provisions which require the Company to hold the investments for a specified time horizon and have limited liquidity.
The Company is a holding company, receiving cash principally through sales of its securities, borrowings and management fees charged to its subsidiaries. The Company's insurance subsidiaries are subject to dividend restrictions as described in Note Q of the Notes to the Consolidated Financial Statements. The ability of insurance companies to underwrite insurance is based on maintaining liquidity and capital resources sufficient to pay claims and expenses as they become due.
All of the Company's insurance subsidiaries, except Lyndon Life, Gulfco Life and Acceleration, are currently rated A- ("Excellent") by A.M. Best Company, Inc. ("A.M. Best"). A.M. Best's current ratings for Lyndon Life and Gulfco Life are B++ ("Very Good"), and its rating for Acceleration is B+("Very ). Standard & Poor's ("S&P") has assigned a financial strength rating of A+ ("Strong") to all of the Company's insurance subsidiaries, except for Regency, which is rated A ("Strong") and Acceleration and Gulfco, which have not been assigned ratings by S&P.
In order to maintain Frontier's current rating with A.M. Best, the Company has made certain commitments, including maintaining a minimum statutory surplus level of $250 million and limiting its premium-to-surplus ratio to no more than 1.75 to 1.
In 1998, the NAIC adopted codified statutory accounting principles ("Codification"). Codification will likely change, to some extent, prescribed statutory accounting practices and may result in changes to the accounting practices that the Ccompany's insurance subsidiaries use to prepare their statutory-basis financial statements. Codification will require adoption by the various states before it becomes the prescribed statutory basis of accounting for insurance companies domesticated within those states. Accordingly, before Codification becomes effective for the Company's insurance subsidiaries, their respective state of domicile must adopt Codification as the prescribed basis of accounting for domestic insurers to report their statutory-basis results to the insurance department. At this time, it is unclear which of the various states will adopt Codification. Management has not yet determined the impact of Codification on the statutory surplus of the Company's insurance subsidiaries.
The thrust of these regulatory efforts is to improve the solvency of insurance companies. These regulatory initiatives, and the overall focus on solvency, may intensify the restructuring and consolidation of the insurance industry. While the impact of these regulatory efforts on the Company's operations cannot be quantified until enacted, the Company believes it will be adequately positioned to compete in an environment of more stringent regulation.
The Company has a committee comprised of senior management from the corporate office and from each of its subsidiaries to develop and implement a uniform and complete Year 2000 compliance plan. An assessment of all systems that could be affected by Year 2000 issues has been completed. For its information technology ("IT") exposures, the Company is nearing completion of the remediation of its systems. Those remediated systems which have been implemented have been tested for compliance for: 20th century system dates with current and 21st century data and, with the exception of one system, 21st century system dates with 20th and 21st century data. Processes and procedures are currently in place to ensure that all future IT development and testing follow Year 2000 standards; that all projects undertaken in the interim deliver Year 2000 compliant solutions; that all future third-party hardware and software acquisitions are Year 2000 compliant; and that all commercial third-party service providers, including agents and program administrators, are queried regarding their Year 2000 compliance plans.
The Company, through its subsidiary United Capitol, in the ordinary course of business, writes insurance on accounts which have hazardous, unique or unusual risk characteristics. Since United Capitol's organization in 1986, its liability policies have included an absolute pollution coverage exclusion, except for policies specifically designed and underwritten to cover environmental exposures pollution. In addition, United Capitol's product liability and other primary general liability policies contain exclusions for coverage of claims for bodily injury or property damage caused by exposure to asbestos, other than for the policies providing coverage to asbestos abatement contractors for third party claims alleging bodily injury or property damage as a result of exposure to asbestos. Employees of the insured contractor and others required to be in the abatement area are excluded from coverage.