The following summary sets forth selected financial data with respect to AIG for the five fiscal years ended December 31, 2000. The balance sheet and income statement data have been derived from AIG's consolidated financial statements which have been audited, for fiscal years through 1998 by Johnson Lambert & Co., AIIG's independent auditors and, for fiscal years 2000 and 1999 by Deloitte & Touche, AIG's independent auditors. The data set forth below should be read in conjunction with the audited financial statements and notes thereto included elsewhere herein.
The following discussion presents the financial condition and results of operation for AIG combined with the financial condition and results of operation for its predecessor entity, AIIG, for the periods and as of the dates indicated.
Average invested assets including cash equivalents increased by $3,479,926 or 7.8% to $47,888,738 in 2000 compared to $44,408,812 in 1999. 1999 average invested assets increased by 1% from $43,999,453 in 1998. Investment yield including realized capital gains and losses in 2000 was 4.3% as compared to 6.1% in 1999 and 5.6% in 1998. Excluding realized gains and losses, the yield was 4.64% in 2000, 5.2% in 1999 and 5.1% in 1998. The decrease in investment yield from 1999 to 2000 is primarily due to an increase in equity holdings.
The composition of the investment portfolio at December 31, 1999 and 1998 is as follows:
2000 1999 ---- ---- U.S. Treasury notes 0% 4% Mortgage backed securities and obligations of U.S. Government agencies 44 57 Corporate debt securities 6 3 Obligations of state and political subdivisions 16 15 Equity securities 34 21 ---- ---- 100% 100% ==== ====
Losses and loss adjustment expenses incurred decreased by 7.6% to $6,231,210 in 2000 from $6,744,893 in 1999, and for 1999 increased by 40.6% from $4,797,657 in 1998. These amounts include favorable development of prior years' estimates of losses and loss adjustment expense of approximately $0 in 2000, $2,533,000 in 1999 and $4,883,000 in 1998. Prior year incurred estimates were not reduced in 2000 due to uncertainties that management believes still exist regarding these years. Management will review prior year reserves again in 2001. AIG's loss ratio, calculated as the ratio of losses and loss adjustment expense to premiums earned, is 95.2% in 2000, 105.6% in 1999 and 81.3% in 1998. The ratio calculated using only losses and loss adjustment expenses incurred for the current year (excluding the effects of favorable development and excluding reductions to retrocession premiums) is 95.2% in 2000, 149.5% in 1999, 167.8% in 1998.
Favorable development on prior year losses is attributable to various economic trends and factors. In a strong economic environment, fewer professional liability claims occur since fewer companies are experiencing the kind of financial stress or failure that can often lead to such claims. However, AIG has noted that under the CNA program, loss frequency has increased in recent years while loss severity has remained constant. This increase in loss frequency can be
attributed to CNA's implementation of a step plan (also see above discussion of premiums) in 1995 that was designed to attract a large number of new insureds, predominantly smaller firms, to the program. CNA expected loss severity to decrease and offset the effects of increases in loss frequency, but to date this decrease has not occurred. Accordingly, losses have trended upward in the most recent years. Additionally, in recent years, many of the CNA insureds have opted to purchase defense coverage outside of policy limits which results in larger reserve requirements.
Effective December 2, 1999, the date of redomestication to Bermuda, the Company ceased to pay corporate income taxes, which meant the Company's deferred tax asset could not be utilized. As the Company reported a tax loss for the period ended December 2, 1999, a tax benefit resulted.
As of December 31, 2000, total invested assets amounted to $45,827,405, an increase of $6,546,148 or 16.7% from $39,281,257 at December 31, 1999. Cash balances decreased from $5,127,555 at December 31, 1999 to $2,061,333 at December 31, 2000. The amount of cash and cash equivalents varies depending on the maturities of fixed term investments and on the level of funds invested in money market mutual funds. The ratio of cash and invested assets to total liabilities and stockholders' equity at December 31, 2000 was .94 to 1, unchanged from December 31, 1999.
AIG's gross premiums assumed in 2000 amounted to $6,276,434, a decrease of $429,312 from 1999. Gross premium assumed in 1999 decreased by $530,103, or 8.3% from 1998. Assumed reinsurance premiums receivable represents current assumed premiums receivable less commissions payable to the fronting carriers. This balance is $115,256 at December 31, 2000, $0 at December 31, 1999. This balance also fluctuates due to the timing of renewal premium written. The increase in premiums has also resulted in a direct increase in policy acquisition costs, unearned premiums, fixed commissions paid to CNA as part of its quota share agreement, and loss reserves.
Reinsurance recoveries represent AIG's estimate of losses to be reimbursed by its reinsurer from future loss payments. AIG (through AIC) entered into excess of loss retrocession agreements to limit its retained risk on any one claim underwritten by Coregis Group, Inc. (formerly Crum and Forster Managers Corporation), to $50,000 in 1989 and 1990 and $62,500 in 1991 through mid-1993, subject to specified maximum recoveries for each contract year. Retrocession premiums ceded by AIG are adjustable within a specified range based on actual experience under each contract. Amounts recoverable from the reinsurers pursuant to retrocession agreements have been estimated using actuarial assumptions consistent with those used in establishing the liability for unpaid losses and loss adjustment expenses.
Reinsurance balances payable represent AIG's estimate of the premiums due to the Company's reinsurer under the retrocession agreements described above, and amounts currently due for losses and loss adjustment expenses payable. The estimate of reinsurance balances due for retrospective premiums decreased by $0, $182,959 and $131,250 during 2000, 1999 and 1998, respectively. Including loss and loss adjustment expenses currently due, reinsurance balances payable increased from $96,108 at December 31, 1999 to $306,529 at December 31, 2000, an increase of $210,421, or 218.9%.
The result of this process is that twice a year, the actuary has made recommendations of a range of ultimate loss estimate to AIC's Board of Directors, which for each period has selected ultimate loss estimates that fall within that range. Based on the foregoing practice, the estimated loss ratio has been updated by AIG's Board of Directors approximately once each year.
The following table shows the development of the estimated liability for the previous ten years of the Company's P/C operations:
The above table of losses reestimated has been prepared on a net basis -- i.e., loss and loss adjustment expenses and reinsurance recoveries receivable have not been grossed-up, as required under FAS 113. The schedule has been prepared on a net basis due to the relative immateriality of reinsurance balances when considered in relation to total loss and loss adjustment expense reserves, and due to the cost/benefit of not providing such information.
The lower section of the table shows the cumulative amount paid with respect to the previously recorded liability as of the end of each succeeding year. For example, the 1994 year end liability was originally $21,264,000. As of December 31, 2000, the Company had paid $9,007,000 of the currently estimated $9,072,000 of losses and LAE that had been incurred for 1994 and prior years through the end of 2000; thus an estimated $65,000 in losses incurred through 1994 remain unpaid as of the current financial statement date.
The Company does not believe its operations have been materially affected by inflation. The potential adverse impacts of inflation include: (a) a decline in the market value of the Company's fixed maturity investment portfolio; (b) an increase in the ultimate cost of settling claims which remain unresolved for a significant period of time; and (c) an increase in the Company's operating expenses. However, the Company generally holds its fixed maturity investments to maturity and currently believes that the yield is adequate to compensate the Company for the risk of inflation. In addition, any increase from inflation in the ultimate cost of settling unpaid claims will be offset by investment income earned for the benefit of the client during the period that the claim is outstanding. Finally, the increase in operating expenses resulting from inflation should generally be matched by similar inflationary increases in the premium rates.
Market risk generally represents the risk of loss that may result from potential change in the value of a financial instrument due to a variety of market conditions. The Company's exposure to market risk is generally limited to potential losses arising from changes in the level of volatility of interest rates on market values of investment holdings. The Company does not hold or issue derivative financial instruments for either trading or speculative purposes.
The Company only invests in U.S. dollar denominated financial instruments and does not believe it has any exposure to foreign exchange risk.
On June 1, 2000, the Board of Directors of Investco, which holds almost all of the Company's investment portfolio, authorized Investco to spend up to $1 million to purchase outstanding Common Shares of the Company. On September 8, 2000, the Bermuda Monetary Authority authorized the purchase of up to 15,000 Common Shares pursuant to the June 1 Board authorization. Such purchases are effected through privately negotiated transactions and are in addition to Investco's practice of redeeming the shares of individuals who have died or retired from the practice of public accounting. To date, Investco has purchased 9,893 Common Shares for an aggregate purchase price of $356,350. The Company paid its twenty-second consecutive quarterly dividend of $0.65 per share during the fourth quarter of 2000.