Direct premiums written for 2002 were $72,803,000, a decrease of $28,150,000 or 28%, from $100,953,000 for 2001. Voluntary direct premiums written for 2002 were $66,806,000, a decrease of $29,709,000 or 31% from $96,515,000 for 2001.
Voluntary personal lines direct premiums written for 2002 were $39,981,000, a decrease of $211,000 or 1% from $40,192,000 in 2001. Private passenger automobile direct premiums written, which comprised 73% and 74% of total voluntary personal lines direct premiums written in 2002 and 2001, respectively, decreased 1% in 2002 compared to 2001. This slight decrease in voluntary personal lines direct premiums written is due to rate increases implemented in some territories being more than offset by the effect of the Company's decision not to accept new private passenger automobile (PPA) applications effective April 1, 2002 in certain states where the Company intends to reduce its PPA exposures due to unfavorable market conditions. PPA new business units (PPA policies written by the Company for the first time) decreased 56% to 2,429 in 2002 from 5,565 in 2001. As a result, total voluntary PPA policies in force at December 31, 2002 decreased 10% to 21,407, from 23,890 at December 31, 2001. Homeowners direct premiums written which comprised 26% and 25% of total voluntary personal lines direct premiums written in 2002 and 2001, respectively, increased 1% to $10,349,000 in 2002 from $10,209,000 in 2001.
In order to minimize the adverse impact of assignments from the NYAIP in 2003, the Company has purchased territorial credits from another insurance company pursuant to Section 6.A.7. of the New York Automobile Insurance Plan Manual. The credits against NYAIP assignments are generated by the other insurance company for writing PPA business in certain localities in New York with PPA market availability problems. The other insurance company, by nature of its concentration in PPA business in "credit" territories, generated more credits than it required to offset its NYAIP assignments. The credits purchased will reduce the Company's share of the NYAIP from February 2003 through January 2004. The Company believes that the costs of the credits purchased will be substantially less than the amount the Company would have lost had it written the additional NYAIP business.
Net premiums written decreased $23,445,000 or 25% to $70,528,000 for 2002 from $93,973,000 for 2001, primarily due to the 28% decrease in direct premiums written. Net premiums earned for 2002 were $83,120,000, a decrease of $10,765,000 or 11%, from $93,885,000 in 2001. The decrease in net premiums earned resulted from the 25% decrease in net premiums written. The decrease in net premiums earned was smaller than the decrease in net premiums written since the Company's insurance policies generally earn over a twelve-month policy term. As a result of the decrease in net premiums written that occurred in 2002, it is likely that net premiums earned will continue to decrease throughout 2003.
Net investment income was $10,403,000 in 2002, a decrease of 22% from $13,295,000 in 2001. The average pre-tax yield associated with the investment portfolio decreased 115 basis points to 5.4% for 2002, due to lower available reinvestment rates. Average invested assets for 2002 decreased 3% compared to 2001.
Net realized investment gains were $953,000 for 2002 compared to net realized investment losses of $580,000 for 2001. During the fourth quarter of 2002, the Company sold its entire investment in a real estate investment trust and recorded a realized loss on the transaction of $430,000. The market value of this security was equal to the proceeds from the sale of $586,000. This security was purchased in 1999 and had performed to expectations from the time of purchase until the fourth quarter of 2002. The Company believed that a proposed change in ownership of the trust was not in the best interest of the Company or of other preferred owner interests and as a result concluded that the risks inherent in holding the investment were greater than the loss recorded from its sale. The Company did not realize any other realized investment losses during 2002.
The Company's effective income tax rate increased to 40.5% in 2002 from 34.6% in 2001 primarily due to a reduction in tax-exempt investment income and dividends received.
Involuntary direct premiums written, primarily involuntary private passenger automobile insurance, which comprised 4% and 1% of total direct premiums written during 2001 and 2000, respectively, were $4,438,000 for 2001 compared to $1,518,000 in 2000, an increase of $2,920,000 or 192%. This increase resulted primarily from increased assignments from the NYAIP, which experienced substantial growth in vehicles insured.
Net premiums earned for 2001 were $93,885,000, a decrease of $374,000, or less than 1%, from $94,259,000 in 2000. This decrease in net premiums earned resulted primarily from a decrease in assumed premiums earned and is consistent with the decrease in net written premiums.
Net realized investment losses were $580,000 for 2001 compared to net realized investment gains of $109,000 for 2000. Net realized investment losses for 2001 included $781,000 of unrealized losses related to the Company's fixed maturity investment in a commercial finance company. The Company believes that the decline in fair value of this investment is other than temporary and has therefore recorded a realized loss.
Other revenues were $696,000 for 2001, an increase of $341,000, or 96%, from $355,000 for 2000. This increase resulted from an increase in premium installment fee income and a decrease in charge-offs related to uncollectible premiums receivable. The reduction in charge-offs resulted from a decline in the average age of the Company's premium receivable.
The ratio of amortized deferred policy acquisition costs and other underwriting expenses to net premiums earned increased to 32.9% in 2001 from 32.1% in 2000, primarily due to higher agency incentive commissions and lower commissions earned on ceded reinsurance. Expenses that vary directly with the Company's premium volume, primarily commissions, premium taxes and state assessments, represented 20.7% and 20.0% of net premiums earned in 2001 and 2000, respectively. Certain other underwriting expenses, such as salaries, employee benefits and other operating expenses vary indirectly with volume and comprise the remainder of the Company's underwriting expenses.
The Company establishes reserves for losses and LAE, which are estimates of future payments to be made to settle all insurance claims for reported losses and estimates of incurred but not reported losses based upon past experience modified for current trends. With the exception of workers' compensation losses, loss reserves are not discounted. Estimated amounts of salvage and subrogation on paid and unpaid losses are deducted from the liability for unpaid claims. The estimated liabilities may be more or less than the amount ultimately paid when the claims are settled. Management and the Company's independent consulting actuary regularly review the estimates of reserves needed and any changes are reflected in current operating results.
Loss reserves are established for known claims based on the type and circumstance of the loss and the results of similar losses. For claims not yet reported to the Company, loss reserves are based on statistical information from previous experience periods adjusted for inflation, trends in court decisions and economic conditions. LAE reserves are intended to cover the ultimate cost of investigating all losses that have occurred and defending lawsuits, if any, arising from these losses. LAE reserves are evaluated periodically using statistical techniques which compare current costs with historical data. Inflation is implicitly reflected in the reserving process through analysis of cost trends and review of historical reserve results.
The Company's reserving process is based on the assumption that past experiences, adjusted for the effect of current developments and trends, are relevant in predicting future events. In the absence of specific developments, the process also assumes that the legal climate regarding the claims process and underlying liabilities remains constant. Other assumptions employed by the Company or its actuarial firm change from time to time as circumstances change. In estimating loss and LAE reserves, the Company employs a number of actuarial methods, depending on their applicability to each line of business, in order to balance the advantages and disadvantages of each method. Therefore, a range of estimates is developed for each line of business. However, the Company does not believe it is appropriate to sum the high and low values developed using different actuarial methods for each line of business to determine a range for the Company's total loss and LAE reserves. Therefore the Company's actuary and its consulting actuary only provide the Company with their respective "best estimates" of total loss and LAE reserves by summing their "best estimate" for each line of business. Due to the Company's small size, the presence or absence of a limited number of moderate losses, as well as the timing of the reporting of such losses to the Company by claimants could result in changes in actuarial estimates that are significant to the Company's net income for a quarter or a year. As such, management recognizes that the "best estimate" may not be more accurate than other amounts within a few percentage points of total loss and LAE reserves.
In developing its investment strategy, the Company determines a level of cash and short-term investments which, when combined with expected cash flow, is estimated to be adequate to meet expected cash obligations. Historically, the excess of premiums collected over payments on claims, combined with cash income from investments, has provided the Company with short-term funds in excess of normal operating demands for cash. In 2002 and 2001, however, the Company's operating activities used cash totaling $5,979,000 and $1,549,000, respectively. This increase in cash used by operations was primarily the result of a $14,412,000 (16%) decrease in premiums collected somewhat offset by a $7,050,000 (9%) decrease in loss and LAE payments and a $4,625,000 (15%) decrease in underwriting expense payments. The Company's intention to continue to reduce direct premiums written in business segments where returns are unsatisfactory will likely result in future negative cash flows from operations. The Company believes that careful management of the relationship between assets and liabilities will minimize the likelihood that
At December 31, 2002, $95,905,000, or 49.5%, of the Company's fixed maturity portfolio was invested in mortgage-backed and other asset-backed securities. The Company invests in a variety of collateralized mortgage obligation ("CMO") products but has not invested in the derivative type of CMO products such as interest only, principal only or inverse floating rate securities. All of the Company's CMO investments have a secondary market and their effect on the Company's liquidity does not differ from that of other fixed maturity investments.
During 2002 the Company repurchased 114,300 shares of its common stock at an average price of $21.29 and was holding 1,139,700 shares in treasury as of December 31, 2002.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities. SFAS No. 146 requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. The provisions of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The provisions of SFAS No. 146 are not expected to have any impact on the Company's consolidated financial statements.
In November 2002, FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others". FASB Interpretation No. 45 elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and initial measurement provisions of FASB Interpretation No. 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002. The Company has complied with the required disclosure. The provisions of FASB Interpretation No. 45 are not expected to have any impact on the Company's consolidated financial statements.
The Terrorism Risk Insurance Act of 2002 ("TRIA"), signed into law on November 26, 2002, provides a federal backstop for losses related to the writing of the terrorism peril in property and casualty insurance policies. Under the TRIA, the Company had until February 24, 2003, to notify commercial policyholders about requirements of the law, let them know that the company was required to offer terrorism coverage and let them know how the coverage would be priced.
The Company has distributed disclosure notices to its commercial policyholders. The notices explained the TRIA and notified them of their coverage. Except for a few select cases, full policy limit coverage has been provided for terrorism for policyholders. The terrorism rating plan, with rates that vary based on geographical and risk-type factors, will go into effect in the near future. The plan will charge all commercial policies a nominal terrorism premium to encourage them to accept coverage while minimizing the company's administrative costs.
During 1998, Mutual initiated discussions with the Company concerning proposals for the acquisition of the Company by Mutual. The Company determined that the terms proposed by Mutual were inadequate. The Company also determined that the Management Agreement, as currently written, creates a conflict of interest between the Company and Mutual in their joint operation and prevents the Company's shareholders from realizing the Company's fair value in a sale or merger. Accordingly, on July 23, 1998 the Company gave notice to Mutual of its intention to terminate the Management Agreement effective July 23, 2003. The Boards of Directors of the Company, MNH and Mutual have agreed in principle for Mutual to continue to provide administrative and management services to MGI and to manage the traditional property and casualty insurance business of MNH under a new services agreement. The new arrangement between Mutual and MNH is intended to be effective as of January 1, 2003, thereby superceding the Management Agreement as of that date, and also provides for the pooling of the insurance business traditionally written by each company, in order to achieve common underwriting results.