The executive offices of the Corporation and the administrative offices of the Property and Casualty Group are in Warren, New Jersey. The Property and Casualty Insurance Group maintains zone administrative and branch offices in major cities throughout the United States and also has offices in Canada, Europe, Australia, the Far East and Latin America. Office facilities are leased with the exception of a building in Branchburg, New Jersey. Management considers its office facilities suitable and adequate for the current level of operations. See Note (14) of the notes to consolidated financial statements incorporated by reference from the Corporation's 1998 Annual Report to Shareholders.
The following discussion presents our past results and our expectations for the near term future. The supplementary financial information and the consolidated financial statements and related notes, all of which are integral parts of the following analysis of our results and our financial position, are incorporated by reference from the Corporation's 1998 Annual Report to Shareholders, pages 15, 16 and 40 through 62.
Income from continuing operations, which includes realized investment gains and losses related to such operations, was $707 million in 1998 compared with $770 million in 1997 and $486 million in 1996.
Net income, which includes the results of the discontinued operations, amounted to $707 million in 1998 compared with $770 million in 1997 and $513 million in 1996.
Property and casualty earnings were lower in 1998 compared with 1997. Such earnings in 1997 were substantially higher than in 1996. Property and casualty income after taxes was $620 million in 1998 compared with $670 million in 1997 and $561 million in 1996. The decrease in earnings in 1998 was due to a decline in underwriting results caused in large part by substantially higher catastrophe losses. Investment income increased in 1998 compared with the prior year. The increase in earnings in 1997 was due to highly profitable underwriting results as well as strong growth in investment income compared with 1996. Earnings in 1996 were adversely affected by higher catastrophe losses.
Catastrophe losses were $173 million in 1998, $57 million in 1997 and $142 million in 1996. The 1998 amount was net of reinsurance recoveries of approximately $150 million relating to Hurricane Georges. We did not have any recoveries from our catastrophe reinsurance program during 1997 or 1996 since there were no individual catastrophes for which our losses exceeded the initial retention. Our initial retention level for each catastrophic event is approximately $100 million in the United States and generally $25 million outside the United States.
Premium growth in personal lines was strong in both 1997 and 1998. In commercial lines, intense competition in the worldwide marketplace has made profitable premium growth difficult, particularly in the standard classes, which include multiple peril, casualty and workers' compensation. In 1998, competitors continued to place significant pressure on pricing as they attempted to maintain or increase market share. In an environment where price increases have been difficult to achieve, we have focused on our specialty lines where we emphasize the added value we provide to our customers. Strong growth was achieved in both years in premiums outside the United States, particularly in Europe, our largest foreign market.
In view of the continuing unprofitability of the standard commercial classes, we have accelerated actions to achieve price increases. Our priorities for 1999 are to renew good business at adequate prices and not renew underperforming accounts where we cannot attain price adequacy. This aggressive pricing strategy could cause us to lose some business. Therefore, we expect overall premium growth to be flat in 1999.
Underwriting results were near-breakeven in 1998 compared with profitable results in 1997 and 1996. The combined loss and expense ratio, the common measure of underwriting profitability, was 99.8% in 1998 compared with 96.9% in 1997 and 98.3% in 1996.
Reported premiums from personal insurance increased 5% in 1998 compared with a 26% increase in 1997. The effect on net premiums written of the changes to the reinsurance agreement with Sun Alliance was as follows:
Net premiums written, as adjusted, increased 3% in 1998 compared with 1997 and 9% in 1997 compared with 1996. Our strategy of working closely with our customers and our ability to differentiate our products have enabled us to renew a large percentage of our business. Growth was achieved in 1998 in our executive protection business due to an emphasis on new products. Financial services consolidation together with competition has constrained growth in our financial institutions business. Premium growth in the standard commercial classes continues to be hindered by the intense competition that has driven prices to increasingly unprofitable levels. Premium growth in 1997 for the excess liability component of our casualty coverages and for our executive protection coverages benefited from the changes to our casualty excess of loss reinsurance program. Premium growth in 1998 and 1997 was stronger outside the United States.
Our commercial insurance business produced unprofitable results in 1998 compared with near breakeven underwriting results in 1997 and 1996. The combined loss and expense ratio was 104.5% in 1998 compared with 100.7% in 1997 and 99.7% in 1996.
Multiple peril results were unprofitable in each of the past three years due, in large part, to inadequate prices. Results for this class in 1998 deteriorated in the property component due to higher catastrophe losses. In the liability component, there was an increase in the frequency of large losses in 1998. However, this was offset by negligible multiple peril incurred losses in 1998 relating to asbestos and toxic waste claims on insurance policies written many years ago compared with the substantial incurred losses in 1997 relating to such claims. Results for the multiple peril class were similar in 1997 and 1996 as an improvement in 1997 in the property component, due in part to an absence of catastrophe losses, was offset by higher losses in the liability component resulting from an increase in the frequency of large losses and higher incurred losses relating to asbestos and toxic waste claims. Catastrophe losses represented 8.6 percentage points of the loss ratio for this class in 1998 compared with 1.5 percentage points in 1997 and 4.8 percentage points in 1996.
Our other commercial classes produced near breakeven results in 1998 compared with profitable results in 1997 and near breakeven results in 1996. The deterioration in 1998 was attributable to our aviation business, which produced highly unprofitable results. The improvement in 1997 was primarily attributable to our surety and accident business.
Reinsurance assumed is treaty reinsurance that was assumed from Sun Alliance. The reinsurance agreement with Sun Alliance was terminated effective January 1, 1997. However, due to the lag in our reporting of such business, net premiums written in the first quarter of 1997 included $90 million related to business we assumed from Sun Alliance in the second half of 1996. Net premiums written for this segment were reduced by $94 million and $65 million in the first quarter of 1997 and 1996, respectively, due to the effect of the portfolio transfers of unearned premiums back to Sun Alliance as of January 1 of each year.
Underwriting results for this segment in 1997, which represent our share of the Sun Alliance business for the last six months of 1996, were near breakeven. Underwriting results were also near breakeven in 1996.
Loss reserves are our property and casualty subsidiaries' largest liability. At the end of 1998, gross loss reserves totaled $10.4 billion compared with $9.8 billion and $9.5 billion at year-end 1997 and 1996, respectively. Reinsurance recoverable on such loss reserves was $1.3 billion at year-end 1998 compared with $1.2 billion and $1.8 billion at the end of 1997 and 1996, respectively.
As a result of the changes to the reinsurance agreements with Sun Alliance, there were portfolio transfers of gross loss reserves and reinsurance recoverable as of January 1, 1997 and 1996. The effect of these portfolio transfers was a decrease in gross loss reserves of $184 million and $209 million and a decrease in reinsurance recoverable of $470 million and $244 million in 1997 and 1996, respectively.
Loss reserves, net of reinsurance recoverable, increased by $485 million or 6% in 1998 compared with $809 million or 10% in 1997. Excluding the effect of the 1997 portfolio transfer, net loss reserves increased by $523 million or 7% in 1997. Substantial reserve growth has occurred each year in those liability classes, primarily excess liability and executive protection, that are characterized by delayed loss reporting and extended periods of settlement.
Our most costly asbestos exposure relates to an insurance policy issued to Fibreboard Corporation by Pacific Indemnity Company in 1956. In 1993, Pacific Indemnity Company, a subsidiary of the Corporation, entered into a global settlement agreement with Continental Casualty Company (a subsidiary of CNA Financial Corporation), Fibreboard Corporation, and attorneys representing claimants against Fibreboard for all future asbestos-related bodily injury claims against Fibreboard. This agreement is subject to final appellate court approval. Pursuant to the global settlement agreement, a $1.525 billion trust fund will be established to pay future claims, which are claims that were not filed in court before August 27, 1993. Pacific Indemnity will contribute approximately $538 million to the trust fund and Continental Casualty will contribute the remaining amount. In December 1993, upon execution of the global settlement agreement, Pacific Indemnity and Continental Casualty paid their respective shares into an escrow account. Upon final court approval of the settlement, the amount in the escrow account, including interest earned thereon, will be transferred to the trust fund. All of the parties have agreed to use their best efforts to seek final court approval of the global settlement agreement.
Pacific Indemnity and Continental Casualty reached a separate agreement in 1993 for the handling of all asbestos-related bodily injury claims pending on August 26, 1993 against Fibreboard. Pacific Indemnity's obligation under this agreement with respect to such pending claims is approximately $635 million, all of which has been paid. The agreement further provides that the total responsibility of both insurers with respect to pending and future asbestos-related bodily injury claims against Fibreboard will be shared between Pacific Indemnity and Continental Casualty on an approximate 35% and 65% basis, respectively.
At the same time, Pacific Indemnity, Continental Casualty and Fibreboard entered into a trilateral agreement to settle all present and future asbestos-related bodily injury claims resulting from insurance policies that were, or may have been, issued to Fibreboard by the two insurers. The trilateral agreement will be triggered if the global settlement agreement is ultimately disapproved. Pacific
Indemnity's obligation under the trilateral agreement is therefore similar to, and not duplicative of, that under those agreements described above.
In July 1995, the United States District Court of the Eastern District of Texas approved the global settlement agreement and the trilateral agreement. The judgments approving these agreements were appealed to the United States Court of Appeals for the Fifth Circuit. In July 1996, the Fifth Circuit Court affirmed the 1995 judgments of the District Court. The objectors to the global settlement agreement appealed to the United States Supreme Court. In June 1997, the Supreme Court set aside the ruling by the Fifth Circuit Court that had approved the global settlement agreement and ordered the Fifth Circuit Court to reconsider its approval. In January 1998, the Fifth Circuit Court again affirmed the global settlement agreement. In April 1998, the objectors to the settlement petitioned the Supreme Court to review the decision. In December 1998, argument was held before the Supreme Court on the objectors' challenge. A decision is expected during 1999.
The trilateral agreement was never appealed to the United States Supreme Court and is final. As a result, management continues to believe that the uncertainty of Pacific Indemnity's exposure with respect to asbestos-related bodily injury claims against Fibreboard has been eliminated.
Uncertainties also remain as to the Superfund law itself. Superfund's taxing authority expired on December 31, 1995. Notwithstanding continued pressure by the insurance industry and other interested parties to achieve a legislative solution which would reform the liability provisions of the law, Congress has not yet addressed the issue. It is currently not possible to predict the direction that any reforms may take, when they may occur or the effect that any changes may have on the insurance industry.
Litigation costs remain substantial, particularly for hazardous waste claims. A substantial portion of the funds we have expended to date has been for legal fees incurred in the prolonged litigation of coverage issues. Primary policies provide a limit on indemnity payments but many do not limit defense costs. This unlimited defense provided in the policy sometimes leads to the payment of defense costs in multiples of the indemnity exposure.
Reserves for asbestos and toxic waste claims cannot be estimated with traditional loss reserving techniques that rely on historical accident year loss development factors. We have established case reserves and expense reserves for costs of related litigation where sufficient information has been developed to indicate the involvement of a specific insurance policy. In addition, IBNR reserves have been established to cover additional exposures on both known and unasserted claims. These reserves are continually reviewed and updated. We have evaluated ultimate incurred losses using newly emerging techniques for estimating environmental liabilities and have expanded our claim data base. As a result, we are more confident about the range of likely ultimate incurred losses relating to asbestos and toxic waste claims. Therefore, the incurred losses relating to asbestos and toxic waste claims were only $68 million in 1998, substantially less than the $125 million in 1997 and the $151 million in 1996. Further increases in such loss reserves in 1999 and future years are possible as legal and factual issues concerning these claims continue to be clarified. The amount cannot be reasonably estimated.
analyze credible scientific evidence, including the impact of global climate change, that may affect our potential exposure under insurance policies.
Investment income after taxes increased 7% in 1998 compared with 9% in 1997. Growth was primarily due to increases in invested assets, which reflected strong cash flow from operations over the period, partially offset by lower average yields on new investments.
In 1998, new cash was invested primarily in tax-exempt bonds and, to a lesser extent, equity securities. In 1997, new cash was invested in tax-exempt bonds and, to a lesser extent, corporate bonds and mortgage-backed securities. In addition, in the first quarter of 1997, $250 million of foreign denominated bonds were sold due to the reduction in foreign liabilities resulting from the termination of the reinsurance agreements with Sun Alliance, with the proceeds invested in U.S. dollar denominated securities. In 1996, we invested new cash primarily in mortgage-backed securities and tax-exempt bonds. In each year, we tried to achieve the appropriate mix in our portfolio to balance both investment and tax strategies.
Investment income earned on corporate invested assets and interest and other expenses not allocable to the operating subsidiaries are reflected in the corporate segment. Corporate income after taxes was $23 million in 1998 compared with $36 million in 1997 and $20 million in 1996. The increase in corporate income in 1997 was due primarily to a reduction in interest expense. The lower corporate income in 1998 was due primarily to an increase in interest expense.
We have retained approximately $365 million of land which we expect will be developed in the future. In addition, we have retained approximately $165 million of commercial properties and land parcels under lease.
Real estate operations resulted in a loss after taxes of $2 million in 1998 compared with losses of $5 million in 1997 and $147 million in 1996. The loss in 1996 reflects the $160 million after tax impairment charge. Excluding the impact of the impairment charge, results in 1996 benefited from the sale of several rental properties.
Revenues were $82 million in 1998, $616 million in 1997 and $320 million in 1996. Revenues in 1998 reflect the reduced operating activity as a result of the sale of a substantial portion of our real estate assets in 1997. Revenues in 1997 included $380 million from the November sale of real estate properties. Proceeds received from that sale that related to mortgages receivable are not classified as revenues. Revenues in 1996 included higher levels of revenues from residential development and the sale of rental properties.
The carrying value of the real estate assets we plan to dispose of in the near term is based on the estimated fair value of these assets. The recoverability of the carrying value of the remaining real estate assets is assessed based on our ability to fully recover costs through a future revenue stream. The process by which SFAS No. 121 is applied and necessary write-downs are calculated assumes these properties will be developed and disposed of over a period of time. The assumptions reflect a continued improvement in demand for office space, an increase in rental rates and the ability and intent to obtain financing in order to hold and develop such remaining properties and protect our interests over the long term. Management believes that it has made adequate provisions for impairment of real estate assets. However, if the assets are not sold or developed as presently contemplated, it is possible that additional impairment losses may be recognized.
Fixed maturities which the Corporation and its insurance subsidiaries have the ability and intent to hold to maturity are classified as held-to-maturity. The remaining fixed maturities, which may be sold prior to maturity to support our investment strategies, such as in response to changes in interest rates and the yield curve or to maximize after-tax returns, are classified as available-for-sale. Fixed maturities classified as held-to-maturity are carried at amortized cost while fixed maturities classified as available-for-sale are carried at market value. At December 31, 1998, 15% of the fixed maturity portfolio was classified as held-to-maturity compared with 18% at December 31, 1997 and 22% at December 31, 1996.
The unrealized market appreciation before tax of those fixed maturities carried at amortized cost was $138 million, $147 million and $130 million at December 31, 1998, 1997 and 1996, respectively. Such unrealized appreciation was not reflected in the consolidated financial statements.
In May 1997, the Corporation completed the sale of Chubb Life Insurance Company of America to Jefferson-Pilot Corporation for $875 million in cash, subject to various closing adjustments, none of which were material.
In 1996, the Corporation recognized a loss of $22 million relating to the sale of the life and health insurance operations. The purchase price was not adjusted to reflect results of operations subsequent to December 31, 1996. The discontinued life and health insurance operations did not affect the Corporation's net income in 1997 and 1998 and will not affect net income in future periods. Earnings in 1996 from the discontinued life and health insurance operations were $49 million, including realized investment gains of $8 million.
The table on the following page provides information about all our fixed maturity investments, which are sensitive to changes in interest rates. The table presents cash flows of principal amounts and related weighted average interest rates by expected maturity dates at December 31, 1998 and 1997. The cash flows are based on the earlier of the call date or the maturity date or, for mortgage-backed securities, expected payment patterns. Actual cash flows could differ from the expected amounts.
The Corporation and its property and casualty subsidiaries have consistently invested in high quality marketable securities. As a result, we believe that we have minimal credit quality risk. Taxable bonds in our domestic portfolio comprise U.S. Treasury, government agency, mortgage-backed and corporate securities. During 1998, to increase our investment returns, we shifted a portion of the taxable portfolio from government agency mortgage-backed securities and lower yielding U.S. Treasury securities to commercial mortgage-backed securities and corporate bonds. Approximately 60% of taxable bonds are issued by the U.S. Treasury or U.S. government agencies or rated AA or better by Moody's or Standard and Poor's. Of the tax-exempt bonds, approximately 90% are rated AA or better with more than half rated AAA. Only 1% of our bond portfolio is below investment grade. Taxable bonds have an average maturity of 7 years while tax-exempt bonds mature on average in 9 years.
Mortgage-backed securities comprised 40% of our taxable bond portfolio at both year-end 1998 and 1997. About 40% of our mortgage-backed securities holdings at December 31, 1998 related to residential mortgages consisting of government agency pass-through securities, government agency collateralized mortgage obligations (CMOs) and AAA rated non-agency CMOs backed by government agency collateral or single family home mortgages. The majority of the CMOs are actively traded in
Equity price risk is the potential loss arising from changes in the value of equity securities. In general, equities have more year-to-year price variability than intermediate term high grade bonds. However, returns over longer time frames have been consistently higher. Our equity securities are high quality and readily marketable.
systems used two digits rather than four to define the applicable year. Such systems may recognize the date "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of normal business activities or other unforeseen problems.
The Corporation and its subsidiaries have interaction with many third parties, including producers, reinsurers, financial institutions, vendors, suppliers and others. We have initiated contact with these parties regarding their plans for Year 2000 readiness. We are in the process of evaluating the responses and following up with those parties from whom we have received no response. The information obtained will be used to develop business contingency plans to address any mission critical operations that may be adversely impacted by the noncompliance of a third party with whom we interact. We have electronic data interchanges with some third parties. We are physically testing such interchanges for Year 2000 compliance. We expect that such testing will be completed by June 1999.
We have identified those third parties that are critical to our operations and are assessing risks with respect to the potential failure of such parties to be Year 2000 ready. However, we do not have control over these third parties and are unable to determine whether all such third parties will address the Year 2000 issue successfully, including third parties located outside the United States where it is believed that Year 2000 remediation efforts in general may be less advanced. Management cannot determine the effect on the Corporation's future operating results of the failure of third parties to be Year 2000 ready.
The Year 2000 team has included employees of the Corporation and software consultants. A portion of the remediation effort has been accomplished by redirecting existing systems resources to the Year 2000 effort. However, we do not believe that this has had a significant adverse effect on other systems initiatives.
An additional concern to the Corporation is the potential future impact of the Year 2000 issue on insurance coverages written by our property and casualty subsidiaries. The Year 2000 issue is a risk for some of our insureds and needs to be considered during the underwriting process similar to any other risk to which our customers may be exposed. It is possible that Year 2000 related losses may emerge that would adversely affect operating results in future periods. At this time, in the absence of any significant claims experience, management cannot determine the nature and extent of any losses, the availability of coverage for such losses or the likelihood of significant claims.
On January 1, 1999, eleven of the fifteen member countries of the European Economic and Monetary Union adopted the euro as their common currency, at which time the rates of conversion between the euro and the participating national currencies were fixed. The euro will be introduced gradually over a period of three years. During this transition period, business in the participating countries will be conducted in the euro or the national currency. Once the national currencies are phased out, the euro will be the sole legal currency in these countries.
In August 1998, the Corporation sold $300 million of unsecured 6.15% notes due in 2005 and $100 million of unsecured 6.60% debentures due in 2018 under a previously filed shelf registration. The proceeds were used for general corporate purposes, which included the repurchase of shares of our common stock.
Consolidated financial statements of the Corporation at December 31, 1998 and 1997 and for each of the three years in the period ended December 31, 1998 and the Report of Independent Auditors thereon and the Corporation's unaudited quarterly financial data for the two-year period ended December 31, 1998 are incorporated by reference from the Corporation's 1998 Annual Report to Shareholders, pages 40 through 64.