We believe that challenges facing insurers in 2004 will include: the expense and time required to comply with new corporate governance issues, continued sensitivity to interest rates and fluctuations in the equity market. Property and casualty insurers will also face the possible return to a soft market characterized by price cutting and increased competition. Historical data shows that hard insurance markets typically last no longer than four years. This, coupled with continued weakness in the investment markets, suggests that the insurance industry must continue to make improvements in its underwriting processes. This will be necessary for property and casualty insurers to achieve the combined ratios and return on equity needed to meet customers’ needs while providing adequate returns to investors.
We write the majority of our personal lines business in Iowa, Louisiana, and Texas. In 2003, to improve our underwriting results, we successfully completed the consolidation of our personal lines business to our home office in Cedar Rapids, Iowa. In addition to improving underwriting results, we believe this move will enable us to provide more consistent and efficient service to our agents and policyholders.
Net premiums earned by the life insurance segment in 2003 totaled $29.6 million, compared with $27.9 million in 2002. Annuity deposits collected are not reflected in net premiums earned. Annuity deposits are invested and recorded as future policy benefits. Revenues for fixed annuity products consist of policy surrender charges and investment income earned. In 2003, annuity deposits were $69.1 million, compared with $223.5 million in 2002. We do not write variable annuity products or variable insurance products.
Net investment income increased by $3.0 million, or 3.0 percent, to $108.5 million between 2002 and 2003. More than 90 percent of our investment income originates from interest on fixed maturities. Our remaining investment income is derived from dividends on equity securities, interest on other long-term investments, interest on mortgage loans, interest on policy loans and rent earned from tenants in our home office. The average investment yield, which is investment income divided by average invested assets, was 5.9 percent in 2003, compared with 6.4 percent in 2002. We attribute the decrease between years to the reinvestment of proceeds from maturing fixed maturities and the investment of new funds at lower investment yields during 2003 due to market conditions.
Other underwriting expenses and amortization together increased in 2002 by $10.9 million, or 9.0 percent, to $131.4 million, primarily as the result of the growth in net premiums written.
Interest on policyholder accounts increased to $51.7 million in 2002, compared with $48.2 million in 2001. We lowered interest-crediting rates on new deposits throughout 2002. Much of the growth in interest credited was primarily a result of the interest credited on existing account balances, where the interest crediting rates are higher than the current rates.
Losses and settlement expenses incurred in 2001 totaled $256.1 million, reflecting $303.2 million of losses that occurred in 2001 and $47.0 million of favorable development on losses that occurred prior to 2001. In 2001, the favorable development was concentrated in our commercial automobile liability and other liability lines of business for accidents occurring in years 1998 through 2000.
The existence of certain airborne mold spores resulting from moisture trapped in confined areas had been alleged to cause severe health and environmental hazards. We have current and potential future exposure to mold claims in both our commercial and personal lines of business. While mold is a potential problem in several states, Texas had been at the forefront of mold insurance issues. Our Texas homeowners policies contain a mold exclusion and our Texas commercial property policies include a $25,000 limitation with respect to claims arising from mold. We had also received approval for a total mold exclusion for our commercial general liability policies. As market conditions permit, we plan to implement any coverage reforms permitted by the Texas Department of Insurance that would enable us to reduce our exposure in Texas to claims related to mold. We believe that it is unlikely that any such loss would have a material adverse effect on our financial condition or our cashflows. However, due to the uncertainty of future changes in Texas regulation, we cannot estimate our future probable liability for mold claims. Also, as case law expands, we may be subject to mold-related losses beyond those intended by policy coverage and not addressed by exclusionary or limiting language. Loss reserve additions arising from future unfavorable judicial trends cannot be reasonably estimated at the present time.
Redeemable preferred stock totaling $65.5 million consists of 2,760,000 shares of 6.375 percent Convertible Preferred Stock, Series A, issued at $25 per share in May of 2002. Dividends paid and accrued on our preferred stock in 2003 totaled $4.4 million. Our preferred stock is discussed further in Note 11 of the Notes to Consolidated Financial Statements.
As required by state law, we engage an independent actuary to render opinions as to the adequacy of the statutory reserves we establish. We file the actuarial opinions in those states where we are licensed. There are no material differences between our statutory reserves and those established under accounting principles generally accepted in the United States.
Realized gains or losses on disposition of investments are included in the computation of net income. Cost of investments sold is determined by the specific identification method. Changes in unrealized appreciation and depreciation with respect to available-for-sale fixed maturities and equity securities are reported as a separate component of stockholders’ equity, less applicable income taxes.
Amortization expense totaled $249,000, $470,000, and $845,000 for the years ended December 31, 2003, 2002 and 2001, respectively. We reduced agency relationships by $548,000 in both 2003 and 2002 as a result of an adjustment to the deferred tax asset valuation allowance related to the acquisition of American Indemnity Financial Corporation. Refer to Note 9 for further discussion.
On January 12, 2004, the Financial Accounting Standards Board issued Staff Position 106-1, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003”, which allowed companies to elect a one-time deferral of the recognition of the effects of the Medicare Prescription Drug Act in accounting for their plans under Statement of Financial Accounting Standard No. 106 and in providing disclosures related to the plan required by Statement No. 132 (revised 2003). The Financial Accounting Standards Board allowed the one-time deferral due to the accounting issues raised by the Medicare Prescription Drug Act-in particular, the accounting for the federal subsidy that is not explicitly addressed in Statement No. 106-and due to the fact that uncertainties exist as to the direct effects of the Medicare Prescription Drug Act and its ancillary effects on plan participants.
We write covered call options on our equity security portfolio to generate additional portfolio income. We do not use these or any other instruments for hedging purposes. Covered call options are recorded at fair value and are included in accrued expenses and other liabilities. Any income or gains or losses, including the change in the fair value of the covered call options, is recognized currently in earnings and included in realized investment losses. There were no open covered call options at December 31, 2003 and 2002.
The insurance industry is governed by individual state insurance departments. All of the insurance departments of the states in which we are domiciled have adopted codification of insurance statutory accounting practices effective January 1, 2001. Previously, these principles were prescribed in a variety of publications, as well as state laws, regulations and general administrative rules. Due to the adoption of codification, the effect on the statutory financial statements as of January 1, 2001 was an increase to statutory policyholders’ surplus of approximately $10,300,000. This change does not affect the accompanying financial statements, which are based on accounting principles generally accepted in the United States. Pursuant to codification rules, permitted statutory accounting practices may be utilized with approval from an insurer’s state of domicile insurance department; however, we do not use any statutory permitted practices.
We also have an Employee Stock Ownership Plan for the benefit of eligible employees and their beneficiaries. All employees are eligible to participate in the plan upon completion of one year of service, meeting the hourly requirements with United Fire and attaining age 21. Contributions to this plan are made at our discretion. These contributions are based upon a percentage of total payroll and are allocated to participants on the basis of compensation. We make contributions in stock or cash, which the trustee uses to acquire shares of United Fire stock to allocate to participants’ accounts. As of December 31, 2003, 2002 and 2001, the Employee Stock Ownership Plan owned 126,206, 126,216 and 127,190 shares of United Fire stock, respectively. Shares owned by the Employee Stock Ownership Plan are included in shares issued and outstanding for purposes of calculating earnings per share, and dividends paid on the shares are charged to retained earnings. We made contributions to the plan of $300,000, $90,000 and $60,000 in 2003, 2002 and 2001 respectively.