(a) Includes net premiums written from Syndicate 1265 of $17,365 and $16,832 for 1999 and 1998, respectively.
(b) Includes net premiums earned from Syndicate 1265 of $13,614 and $14,832 for 1999 and 1998, respectively.
The Company's general and administrative expenses consist primarily of compensation expense, employee benefits and rental expense for office facilities. The Company's policy acquisition costs include both brokerage commissions and premium taxes which are primarily based on a percentage of premiums written. Such costs have generally changed in proportion with changes in premium volume. Losses and loss adjustment expenses incurred in connection with insurance claims in any particular year depend upon a variety of factors including the rate of inflation, accident or claim frequency, the occurrence of natural catastrophes and the number of policies written.
Net income for the year ended December 31, 1999, was $16,413,000 or $1.69 per diluted share compared with the year ended December 31, 1998, net income of $18,523,000 or $1.91 per diluted share. Operating income, which excludes the effects of realized investment gains after taxes, was $8,286,000, or $.86 per share, for the year ended December 31, 1999, versus $12,924,000, or $1.33 per share, for the prior year.
For the year ended December 31, 1999, net premiums earned were $56,155,000 as compared with $76,023,000 for 1998. The 1998 amount included approximately $24.7 million relating to two transactions involving assumptions of ocean marine and casualty business. Excluding these one-time items, net premiums earned for the year ended December 31, 1999 would have increased 9%.
Ocean marine net premiums earned increased in 1999 by 5%, excluding one-time items, and is largely attributable to business derived from the Syndicate 1265 segment. Approximately $13.6 million in net premiums earned, mostly ocean marine hull, was produced by Syndicate 1265 in 1999, its first full year of operations, when compared to $700,000, excluding one-time items, in 1998. Net premiums earned from the domestic insurance companies segment were down 24% as competition generally remained intense in 1999 and adversely affected ocean marine premium rates as well as premium renewals. The outlook for 2000 indicates that pricing pressures will remain as the over capacity within this market still exists. Syndicate 1265 will also continue to write at a cautious pace.
The other liability line decreased 26% in 1999, excluding one-time items, when compared to 1998 due to the effects of competitive pricing as well as a decline in premium production. The Company expects the casualty market to remain competitive in 2000 with premiums likely to decline further.
Losses and loss adjustment expenses incurred as a percentage of net premiums earned were 65.6% for the year ended December 31, 1999, as compared to 56.6%, excluding one time items, for the same period of the prior year. The domestic insurance subsidiaries recorded higher loss ratios in the aviation line of business in 1999 due to increases in both the frequency and severity of losses. In addition, the Company's ocean marine line recorded higher loss ratios in 1999, primarily attributable to the loss experience produced from our Syndicate 1265 segment. Syndicate 1265 experienced a relatively high frequency of marine hull claims in 1999.
Net investment income for the year ended December 31, 1999 decreased by 10% from the level of net investment income achieved in 1998. Contributing to the decline were lower overall investment yields and a reduction in invested assets brought about by the payments of a large number of losses on a gross basis in the aviation and umbrella lines of business.
Realized investment gains of $12,504,000 for the year ended December 31, 1999 result in large part from the sale of appreciated equity securities. In addition, sales resulted from monitoring the Company's overall exposure to equity securities to be in accordance with its investment guidelines.
Total investments decreased to $396.7 million at December 31, 1999 primarily due to reductions in unrealized gains on investments as a result of rising interest rates and reductions in the investment portfolio to fund payments of aviation and umbrella losses on a gross basis. These payments contributed to cash flow used in operations in 1999 of $33.6 million. The Company maintains an adequate level of reinsurance to prevent any one loss from significantly affecting net income. However, timing differences between the payment of gross losses by the Company and cash collections received from reinsurers may adversely impact cash flow in any one period.
Reinsurance receivables increased by 28% to $255.8 million as of December 31, 1999. Increases in gross severity losses in the aviation, umbrella and ocean marine lines, of which substantial amounts were ceded under various reinsurance agreements, accounted for the increase.
Accumulated other comprehensive income decreased to $9.9 million from $19.4 million in 1998 and principally reflects the adverse impact of higher interest rates in 1999 on the Company's market value of its fixed income portfolio.
The Company's net premiums earned decreased to $76.0 million in 1998 as compared to $87.5 million in 1997. Premiums earned in 1998 reflected very competitive markets across all lines of business, premiums from Syndicate 1265 and the effects of two transactions involving the assumption of premiums.
Ocean marine earned premiums increased by 20% in 1998 compared to 1997. The increase resulted from a reinsurance transaction involving a one-time assumption of approximately $14.2 million of premiums that emanated from Syndicate 1265, which commenced operations in 1998. Syndicate 1265 contributed an additional $3.6 million in gross direct ocean marine writings in 1998. The domestic insurance companies reported a 9% decrease in earned premiums as competition remained intense and adversely affected premium rates.
Collectively, other liability and other premiums earned were $14.0 million in 1998 compared to $4.3 million in 1997. The increase resulted from the second reinsurance transaction in 1998 that included a one-time assumption of approximately $10.5 million of miscellaneous casualty net premiums. Excluding the effect of this transaction, premiums earned would have decreased approximately 22% in 1998 primarily as a result of the soft casualty market which led to a decline in premium production.
Inland marine gross premium writings increased 15% to $1.3 million in 1998 due in large part to writing policies that are ancillary to its ocean marine risks. Earned premiums were negative due to reinsurance costs for catastrophe protection, reinstatement costs, and quota share reinsurance which collectively amounted to approximately $1.6 million.
Losses and loss adjustment expenses incurred as a percentage of net premiums earned were 66.4% for the year ended December 31, 1998 as compared to 58.0% for the prior year.
The ocean marine loss ratio for Syndicate 1265's assumption of premiums in 1998 was approximately 94% and had the effect of increasing the overall loss ratio significantly. Absent such business, the ocean marine loss ratio would have been approximately 54% as compared to 57% for the prior year. The domestic insurance companies recorded favorable net loss experience in the Company's core ocean marine line largely due to lower retention levels per loss.
Policy acquisition costs as a percentage of net premiums earned for the year ended December 31, 1998 were 13.3% as compared with 18.9% for the prior year. The reduction in the ratio is due to the two transactions involving an assumption of premiums in 1998. Excluding the effect of such business, the ratio would have been approximately 19.7% for 1998. This ratio approximates the ocean marine line of business ratio as those premiums represent a larger percentage of total premiums in 1998 than in 1997.
General and administrative expenses increased by 28% in 1998 over 1997. The increase included operating expenses from Syndicate 1265. Also, certain one-time expenses were incurred in connection with the assumption of premiums and the formation of Syndicate 1265. Lastly, contributing to the overall increase were expenses associated with two employee benefit plans adopted by the Board of Directors in 1998.
Interest expense decreased 5% for the year ended December 31,1998 to $1.4 million primarily as a result of a decrease in average loan principal outstanding.
The Company was able to realize investment gains of $8.6 million in 1998 mainly as a result of the sale of appreciated equity securities in 1998.
Historically, cash flows provided by operating activities were used in investing and financing activities. In 1997 cash inflows increased as premium rates were higher in the ocean marine and aviation lines. Cash flows were used in operating activities in 1999 and 1998 as further declines in premium rates, increases in ceded reinsurance premium costs
In 1999, Vincent T. Papa, a former President and Chief Executive Officer of the Company, filed suit in the New York Supreme Court seeking damages from the Company based upon alleged breaches by the Company of its obligations under an employment agreement with Mr. Papa. The Company intends vigorously to defend itself against such claims and believes it has no further obligations to Mr. Papa.
Statement of Financial Accounting Standards No. 137, "Accounting for Derivative Instruments and Hedging Activities-Deferral of the Effective Date of FASB Statement No. 133", ("SFAS 137") was issued by the FASB in June 1999. SFAS 137 defers the effective date of SFAS 133 to fiscal years beginning after June 15, 2000.
The Company uses derivatives, in the form of an interest rate swap, for hedging purposes as part of its interest rate management. The Company has not yet determined the effect of SFAS 133 on its financial statements.
The Company adopted AICPA Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," ("SOP 98-1") effective January 1, 1999. SOP 98-1 provides standards for capitalizing certain internal costs incurred to develop software used internally. The adoption of SOP 98-1 did not have a material impact on the Company's results of operations or financial condition.
Inflation also affects the final settlement costs of claims which may not be paid for several years. The longer a claim takes to settle, the more significant the impact of inflation on final settlement costs. The Company periodically reviews outstanding claims and adjusts reserves for the pools based on a number of factors, including inflation.