Net investment income, including realized capital gains and losses, includes amounts earned on the Company's investment portfolio and cash on deposit. Net investment income increased $252,137 or 10.3% in 1999 to $2,696,132 from $2,443,995 in 1998. Net investment income in 1998 decreased by $128,544 or 4.9% from the $2,572,539 reported in 1997. Net investment income in 1999 includes net realized capital gains of $532,854 as compared to net realized capital gains in 1998 of $277,627. Net realized capital gains in 1997 were $305,718. Capital losses are used to offset capital gains of prior and future years and recover related income taxes.
1999 1998 ----- ----- U.S. Treasury notes 2% 4% Mortgage backed securities and obligations of U.S. Government agencies 59 41 Corporate debt securities 3 - Obligations of state and political subdivisions 15 36 Equity securities 21 19 ---- ---- 100% 100% ==== ====
Policy acquisition costs of $1,770,098 were expensed in 1999 as compared to $1,641,092 in 1998, an increase of 7.8%. Policy acquisition costs expensed in 1998 reflect an increase of 5.6% from $1,554,025 in 1997. Such costs as a percentage of premiums earned (excluding the effects of reductions to retrocession premiums) are 28.1% in 1999, 28.0% in 1998 and 28.5% in 1997, and result primarily from ceding commissions paid to ceding companies determined contractually pursuant to reinsurance agreements.
AIG implemented Statement of Position 98-5 (SOP 98-5), "Reporting on the Costs of Start-Up Activities", in the first quarter of 1999. With the adoption of SOP 98-5, AIG expensed certain start-up costs associated with the redomestication as incurred (see discussion detailing the redomestication below). Previously, AIG had capitalized these costs to be expensed over a period of 60 months. The adoption of SOP 98-5 has been applied retroactively to the costs of start-up activities that were previously capitalized in order to determine their cumulative effect. The effect of the change for the twelve months ended December 31, 1999 was to decrease income before cumulative effect of a change in accounting principle by $154,466 ($234,000 gross of tax) or $(1.17) per share. The adjustment necessary for retroactive application of SOP 98-5, amount of $154,466 (net of tax), is included in net income for the twelve months ended December 31, 1999.
The Company's cash needs consist of settlement of losses and expenses under its reinsurance treaties and funding day-to-day operations. Management expects to be able to meet these cash needs from cash flows arising from its investment portfolio. Because substantially all of the Company's assets are marketable securities, the Company has sufficient flexibility to provide for unbudgeted cash needs which may arise without resorting to borrowing.
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. Ultimate loss reserves were adjusted downward by the actuary in 1999, which resulted in a decrease in the portion of reinsurance balances payable due for retrospective premiums. The estimate of reinsurance balances due for retrospective premiums decreased by $182,959, $131,250 and $720,298 during 1999, 1998 and 1997, respectively. Including loss and loss adjustment expenses currently due, reinsurance balances payable decreased from $977,976 at December 31, 1998 to $96,108 at December 31, 1999, a decrease of $881,868, or 90.2%.
The consolidated financial statements include the established liability for unpaid losses and loss adjustment expenses ("LAE") of the Company's property/casualty ("P/C") insurance operations. The liabilities for losses and loss adjustment expenses are determined utilizing both case-basis evaluations and actuarial projections, which together represent an estimate of the ultimate net cost of all unpaid losses and LAE incurred through December 31 of each year. These estimates are subject to the effect of trends in future claim severity and frequency. The estimates are continually reviewed
and, as experience develops and new information becomes known, the liability is adjusted as appropriate. Such adjustments are reflected in current financial reports.
In preparing ultimate loss and allocated loss adjustment expenses, the Company's actuary examined a variety of methods. The method most commonly relied up on was the Generalized Cape Cod Method, which was applied to the incurred, adjusted incurred and paid losses. The case reserving practices for the CNA business differ significantly from those of the Coregis business, therefore, the actuary performed a claims-adjusted incurred loss development method on the CNA data, which adjusted the reserves upward to reflect what would have been outstanding reserves at the level of the Coregis reserves. The actuary selected the Generalized Cape Cod Method applied to claims-adjusted incurred losses to determine ultimate loss estimates for CNA. The actuary also applied the standard paid and incurred loss development methods to the CNA data, however, these were not selected because of the belief that the adjusted incurred method is more representative of the Company's claims history.
The result of this process is that twice a year, the actuary has made recommendations to AIC's Board of Directors, which for each period adopted the recommendation. Based on the foregoing practice, the estimated loss ratio has been changed by AIG's Board of Directors approximately once each year.
The following table shows the development of the estimated liability for the previous eleven years of the Company's P/C operations:
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, 1999, the Company had paid $8,920,000 of the currently estimated $9,074,000 of losses and LAE that had been incurred for 1994 and prior years through the end of 1999; thus an estimated $154,000 in losses incurred through 1994 remain unpaid as of the current financial statement date.
The majority of insurance transactions affecting the Company are originated by CNA, the company's primary insurance carrier, operating systems, with quarterly reporting to the Company. USAOM, VIM and CNA had performed extensive review of their hardware and software systems during 1999 and believed they were fully Year 2000 compliant.
Since the passing of Year 2000, the Company has not been made aware by USAOM, VIM or CNA of any non-compliance and believes that there has been no negative effect on its results due to the Year 2000 problem.