from the statutory financial statements of the Company and, in the opinion of management, fairly reflect the specified data for the periods presented. The information set forth below should be read in conjunction with, and is qualified by reference to, the Company's financial statements and related notes thereto included elsewhere herein.
owned subsidiaries, including, since August 4, 1999, New Jersey State Medical Underwriters, Inc. and its wholly-owned subsidiaries ("the Underwriter"). The consolidated financial statements for 1999 prior to August 4, 1999, and for 1998, 1997 and 1996, include the accounts and operations of the former parent company Medical Inter-Insurance Exchange (the "Exchange") and its wholly-owned subsidiaries.
The Plan has been challenged in two court actions. On February 14, 2000, the Appellate Division of the Superior Court of New Jersey affirmed the Commissioner's order approving the Plan of Reorganization, rejecting all of appellants' contentions, in response to an appeal filed by three individual insureds challenging the Commissioner's order. On September 19, 2000, the appellants' petition for review of the Appellate Division decision by the New Jersey Supreme Court was denied. The matter has now been finally concluded in the Company's favor. A second court action challenging certain aspects of the Plan of Reorganization and seeking damages and injunctive relief that was filed by five individual insureds in January 1999 was dismissed by the trial court in August 1999 and is now on appeal. The Company intends to vigorously oppose the appeal.
and other insureds are evaluated based on current and historical losses, LAE (defined below) and other actuarially significant data. The process may result in changes in rates for certain exposure classes.
The Company reinsures its risks primarily under two reinsurance contracts, a specific excess of loss contract ("Specific Contract") and an aggregate excess of loss contract ("Aggregate Contract"). During 2000, the Company's retention for casualty business under the Specific Contract was $10 million per loss. For medical professional liability and commercial general liability business, coverage was provided up to $25 million per loss above the retention. For other casualty business, coverage was provided up to $15 million per loss above the retention. The Company retains a 10% co-participation in covered losses. The Company has maintained specific excess of loss reinsurance coverage generally similar to that described for several years.
The Company's continued focus on expense controls resulted in lower underwriting expenses in 2000. However, a greater proportion of the Company's business is written by the broker and agent distribution channels, resulting in increased marketing expenses. The Company believes that these relationships will reduce the need to make other significant distribution and administrative expenditures. Commissions for policies sold through brokers and agents typically range from 2.0%
Statements in this Annual Report that are not strictly historical constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially from such statements. In addition to specific uncertainties and other factors mentioned elsewhere in this report, these uncertainties and other factors include, but are not limited to: (i) the Company having sufficient liquidity and working capital; (ii) the Company's ability to achieve consistent profitable growth; (iii) the Company's ability to diversify its product lines; (iv) the continued adequacy of the Company's loss and loss adjustment expense reserves; (v) the Company's avoidance of any material loss on collection of reinsurance recoverables; (vi) increased competitive pressure; (vii) the loss of significant customers; (viii) general economic conditions, including changing interest rates, rates of inflation and the performance of the financial markets; (ix) judicial decisions and rulings; (x) changes in domestic and foreign laws, regulations and taxes; and (xi) effects of acquisitions and divestitures. The words "believe," "expect," "anticipate," "project," and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates.
OTHER REVENUE. Other revenue decreased $0.8 million, or 10.5%, to $7.5 million in 2000 compared to $8.3 million in 1999. In 2000 other revenue was primarily composed of $8.0 million associated with the Company's leasing, brokerage and other businesses, offset by a $0.5 million loss on the sale of substantially all of the assets of the Company's reinsurance intermediary, Pegasus Advisors, Inc., effective July 1, 2000. The sale transaction resulted in a write-off of $1.7 million of goodwill and deferral of $1.2 million of gain in consideration of price adjustments features contained in the sale agreement. In 1999 other revenue consisted primarily of $3.4 million of revenues associated with the Company's leasing, brokerage and other businesses, acquired by the Company in the acquisition of the Underwriter on August 4, 1999, a gain of $3.5 million resulting from common stock received during
1999 in the demutualization of Manulife Financial Corp. and a $1.0 million death benefit received during 1999 from a corporate owned life insurance policy.
OTHER EXPENSES. Other expenses increased $2.5 million, or 74.9%, to $5.8 million in 2000 from $3.3 million in 1999. In 2000, other expenses consisted of the costs associated with the leasing, brokerage and other businesses acquired by the Company in the acquisition of the Underwriter on August 4, 1999. The increase in other expenses in 2000 was primarily due to twelve months of activity for the acquired businesses in 2000 as compared to slightly less than five months of activity in 1999.
RESTRUCTURING CHARGE. The Company undertook a restructuring during the second quarter of 1999 and on June 23, 1999 announced the reduction of regional and home office staff and the closing of the regional offices in Boston and Atlanta to centralize their functions at the Company's home office. The Company recognized a pre-tax charge of $2.4 million related to this restructuring. All actions contemplated by the charge were taken in June 1999 and no adjustments to the restructuring charge reserve were recorded during the balance of 1999. No similar event occurred during 2000.
YEAR ENDED DECEMBER 31, 1999, COMPARED TO YEAR ENDED DECEMBER 31, 1998
UNDERWRITING EXPENSES Underwriting expenses increased $0.5 million, or 1.3%, to $42.6 million in 1999 from $42.1 million in 1998. The increase in expenses was attributable to the costs of acquiring new business, primarily through a broker distribution network, and to the increased infrastructure costs necessary to service the increased volume of business activity in 1999. The ratio of underwriting expenses to net premiums earned, however, declined to 22.7% in 1999 from 25.9% in 1998. This improvement was primarily the result of greater economies of scale present with the larger premium in 1999 combined with the impact of the Company's cost reduction efforts, including the restructuring undertaken in June 1999.
FUNDS HELD CHARGES Funds held charges increased $0.9 million, or 6.8%, to $14.3 million in 1999 from $13.4 million in 1998. Funds held charges relate to the Company's ceded aggregate reinsurance contracts, for which balances due to reinsurers are withheld as collateral for losses and loss adjustment expenses ceded under the contracts. The increase in funds held charges in 1999 was primarily due to the increase in reinsurance recoverable on unpaid losses ceded under the contracts during 1999.
The primary sources of the Company's liquidity are insurance and assumed reinsurance premiums collected, net investment income, proceeds from the maturity or sale of invested assets, recoveries from reinsurance and revenues from non-insurance operations. Funds are used to pay losses and LAE, operating expenses, reinsurance premiums and taxes. The Company's net cash flow from operating activities was $59.4 million in 2000 compared to $107.4 million in 1999 and $92.7 million in 1998. The decrease in positive cash flow during this period resulted from increases in paid losses and LAE offset, in part, by decreases in paid underwriting expenses and federal income taxes. Because of the inherent unpredictability related to the timing of the payment of claims, it is not unusual for cash flow from operations for a medical malpractice insurance company to vary, perhaps substantially, from year to year.
At December 31, 2000 and 1999, the Company held collateral of $306.7 million and $271.6 million, respectively, in the form of funds held, and $173.2 million and $178.7 million, respectively, in the form of letters of credit, for recoverable amounts on ceded unpaid losses and LAE under certain reinsurance contracts. Under the contracts, reinsurers may require that a trust fund be established to hold the collateral should one or more triggering events occur, such as a downgrade in the Company's A.M. Best rating below B+, a reduction in statutory capital and surplus to less than $60 million, or a change in control. Otherwise no restrictions are placed on investments held in support of the funds held. In accordance with the provisions of the reinsurance contracts, the funds held are credited with interest at contractual rates ranging from 7.5% to 8.6%, which is recorded as an expense in the year incurred.
Market risk represents the potential for loss due to adverse changes in the fair value of financial instruments. The market risk associated with the financial instruments of the Company relates to the investment portfolio, which exposes the Company to risks related to unforeseen changes in interest rates, credit quality, prepayments and valuations. Analytical tools and monitoring systems are in place to continually assess and react to each of these elements of market risk.
The tables below provide, as of December 31, 2000 and 1999, information about the Company's fixed maturity investments, which are sensitive to changes in interest rates, showing principal amounts and the average yield applicable thereto by expected maturity date and type of investment. The expected maturities displayed have been compiled based upon the earlier of the investment call date or the maturity date or, for mortgage-backed securities, expected payment patterns based on statistical analysis and management's judgment. Actual cash flows could differ, perhaps significantly, from the expected amounts.