The Company's retrocession program includes aggregate excess of loss coverages in which accident year losses exceeding a specified loss ratio are ceded to retrocessionaires. These contracts also contain contingent premium provisions whereby the Company is required to cede additional premiums equal to a specified portion of the covered losses. As described in the preceding paragraph, the accident year losses incurred in 2001, primarily as a result of the insurance losses arising from the events of September 11, exceeded the specified loss ratio and, accordingly, accruals for reinsurance recoverables and ceded premium payables were reflected in the accompanying consolidated financial statements in accordance with the terms of the underlying retrocession contracts. The associated accrued reinsurance recoverables will be collected when the underlying paid losses exceed the specified loss ratios.
Substantially all of the Company's retrocessionaires are large, highly rated reinsurance entities. At this time, management does not anticipate that any significant portion of its estimated recoveries will be uncollectible.
Income tax benefits partially offset the significant pre-tax operating loss generated in 2001. Such recorded tax benefits include the impact of the Company holding a significant portion of its overall investment portfolio in securities that are substantially exempt from U.S. taxation and the treatment of certain proceeds received in connection with the resolution of issues involving a previous acquisition as a purchase price adjustment for tax purposes.
Net earnings decreased $139 million or 19% in 2000, including a decrease in after-tax net realized gains on investments of $100 million. Excluding after-tax net realized gains on investments, net earnings decreased $39 million or 14% in 2000. This decrease reflects deterioration of underwriting results, including adverse development on prior year recorded losses. The significant level of adverse development on prior year recorded losses is primarily attributable to the combination of the effects of continued insufficient pricing within the overall property and casualty insurance/reinsurance industry and the insurance industry's undervaluing the initial loss estimates for certain European windstorms occurring late in December 1999. Based on the continued escalation in reported losses relative to associated premiums, it became more apparent during 2000 that the level of general price erosion that occurred in the primary property and casualty insurance industry in recent years was significantly greater than had been previously contemplated. In response to this new information, it became necessary for the Company to increase claim reserves to reflect the higher ultimate loss projections resulting from this increasing trend of claim development on these more recent underwriting years.
Typically, the underwriting performance of property and casualty business is measured in terms of a combined ratio. The combined ratio is the sum of the loss ratio and the underwriting expense ratio, with a ratio lower than 100% indicating an underwriting profit and a ratio greater than 100% indicating an underwriting loss. Although the combined ratio has been greater than 100% for the three years presented above, the operating results of insurance/reinsurance companies include net investment income which generally yields an overall operating profit.
Earnings (loss) before income taxes and cumulative effect of change in accounting principle, excluding net realized gains on investments, decreased $976 million in 2001, primarily attributable to the increase in the combined ratio (including the significant impact of the events of September 11) and the decrease in net investment income discussed above. Earnings before income taxes and cumulative effect of change in accounting principle, 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.
Consistent with experience in the domestic property and casualty business, the significant increase in the 2001 combined ratio is primarily attributable to higher levels of ceded premiums and incurred losses resulting from the events of September 11. Excluding this impact, the 2001 combined ratio would have been 114.8%. The relatively high combined ratios in 2001 (excluding the impact of the events of September 11), 2000 and 1999 primarily reflect the effects of continued insufficient pricing within the overall property and casualty insurance/reinsurance industry in recent years and adverse development on prior year recorded losses. The increase in the combined ratio in 2000 includes the impact of significant adverse development relating to certain European windstorms occurring late in 1999.
Revenues, which consist of net premiums earned, net investment income, net realized gains on investments and other revenues, including fees generated from investment-related life reinsurance products and financial reinsurance transactions, increased $259 million or 12% in 2001. This increase was primarily attributable to growth in the international traditional life and health business (principally in Europe and Latin America), somewhat offset by a decrease in net realized gains on investments. Revenues increased $418 million or 23% in 2000. This increase was primarily attributable to growth in the domestic traditional life and credit life business and an increase in net realized gains on investments.
Earnings before income taxes and cumulative effect of change in accounting principle increased $22 million or 9% in 2001, including a $41 million decrease in net realized gains on investments. Excluding net realized gains on investments, earnings before income taxes and cumulative effect of change in accounting principle increased $63 million or 45% in 2001, primarily attributable to the increase in revenues discussed above and more favorable claim experience as compared to 2000 (particularly in the international individual disability line of business). Earnings before income taxes and cumulative effect of change in accounting principle 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 and cumulative effect of change in accounting principle decreased $21 million or 13% in 2000, primarily attributable to an increase in claims experience.
Cash flows from operating activities, which primarily consists of premiums collected during the period and payments made for claims and claim expenses, increased $74 million in 2001, primarily attributable to a decrease in claim settlements relative to the collection of premiums, somewhat offset by an increase in reinsurance recoverables under the Company's aggregate excess retrocession programs. Cash flows from operating activities decreased $1,030 million in 2000, primarily as a result of an escalation in claim-related payments attributable to higher levels of incurred claims and claim expenses in recent years.
The decrease in unrealized gains on investment securities before deferred income taxes in 2001 is primarily due to the impact of realized gains recognized, somewhat offset by the concentration of fixed maturity debt securities held in the investment portfolio and the effects of a general decrease in interest rates which occurred in 2001.
Domestic Investment Operations. The Company's domestic property and casualty investment portfolios are principally invested in tax-exempt state and municipal bonds, which the Company believes provide the most attractive after-tax yield. The Company's domestic life investment portfolios are largely invested in taxable debt securities.
International Investment Operations. The investment portfolios of the Company's international operations (other than certain equity portfolios, which are managed by outside managers) are managed by the GE Frankona Re Group's investment personnel based in Munich, within guidelines established by the management of the GE Frankona Re Group and under the overall supervision and review of ERC's investment department.
Most fixed maturity securities within the GE Frankona Re Group's investment portfolios have a term of less than ten years. The fixed maturity securities consist of high credit quality securities, and almost all bonds are investment grade securities with a comparable average rating equal to or above a Moody's or S&P "AA" rating. Fixed maturity securities include German and Danish mortgage-backed securities, although these mortgage-backed securities have significantly less prepayment risk than typical U.S. mortgage-backed securities, as the German and Danish tax and social environments are not conducive to risks of prepayment of interest and principal. Equity securities and other invested assets were internationally diversified with principal holdings in Germany, the United Kingdom and the United States.
One means of assessing exposure to interest rate changes is a duration-based analysis that measures the potential loss in net earnings resulting from a hypothetical decrease in interest rates of 100 basis points across all maturities (sometimes referred to as a "parallel shift in the yield curve"). Under this model with all else constant, it is estimated that such a decrease, including repricing in the securities portfolio, would reduce the 2002 net earnings of the Company based on year-end 2001 positions by an insignificant amount. Based on positions at year-end 2000, the pro forma effect on 2001 net earnings of such a decrease in interest rates was also estimated to be an insignificant amount.
The geographic distribution of the Company's operations is diverse. One means of assessing exposure to changes in currency exchange rates is to model effects on reported earnings using a sensitivity analysis. Year-end 2001 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 currencies. 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, management estimated at year-end 2001 that such a decrease would have an insignificant effect on 2002 earnings of the Company.
High quality financial statements require rigorous application of high quality accounting policies. The policies discussed below are considered by management critical to an understanding of the Company's financial statements because their application places the most significant demands on management's judgment, with reporting results relying on estimation about the effect of matters that are inherently uncertain. Specific risks for these critical accounting policies are described in the following paragraphs. For all of these policies, management cautions that future events rarely develop exactly as forecast, and the best estimates routinely require adjustment.
Insurance related liabilities and reserves differ for short and long duration insurance contracts. Short-duration contracts such as property and casualty policies are accounted for based on actuarial estimates of the amount of loss inherent in that period's claims, including losses for which claims have not yet been reported. Short-duration contract loss estimates rely on actuarial observations of ultimate loss experience for similar historical events. Measurement of long-duration insurance liabilities (such as term and whole life insurance policies) also is based on approved actuarial techniques, but necessarily includes assumptions about mortality, lapse rates and future yield on related investments. The Company's insurance related liabilities and reserves totaled $31 billion at year-end 2001. Of that total, approximately $20 billion related to unpaid claims and claims adjustment expenses for short-duration insurance coverage. As discussed on page 14, there has been a recent shift in the source of adverse loss development away from property to liability coverage. Management continually evaluates the potential for changes in loss estimates, both positive and negative, and uses the results of these evaluations both to adjust recorded provisions and to adjust underwriting criteria and product offerings. The potential for further adverse loss
Other significant accounting policies, not involving the same level of measurement uncertainties as those discussed above, are nevertheless important to an understanding of the financial statements. Policies related to revenue recognition, financial instruments and consolidation policy require difficult judgments on complex matters that are often subject to multiple sources of authoritative guidance. Certain of these matters are among topics currently under reexamination by accounting standards setters and regulators. Although no specific conclusions reached by these standard setters appear likely to cause a material change in the Corporation's accounting policies, outcomes cannot be predicted with confidence. Also see note 2, Summary of Significant Accounting Policies, which discusses accounting policies that must be selected by management when there are acceptable alternatives.
Major provisions of new accounting standards that may be significant to the Company's financial statements in the future are described in the following paragraphs.
SFAS 143, Accounting for Asset Retirement Obligations, requires recognition of the fair value of obligations associated with the retirement of long-lived assets when there is a legal obligation to incur such costs. This amount is accounted for like an additional element of the corresponding asset's cost, and is depreciated over that asset's useful life. SFAS 143 will be effective for the Company on January 1, 2003. Management has not yet determined the effects of adopting this standard on the Company's financial position and results of operations.