A.M. Best Company and the Insurance Information Institute have estimated that net written premiums for all U.S. property and casualty insurers fell by 0.4% in 2008. This followed a drop of 1% in 2007. The property and casualty industry’s net income was in excess of $60.0 billion in 2007 and is projected to be approximately $14.0 billion in 2008. The decrease was driven by a projected $21.5 billion underwriting loss, resulting from soft market conditions, weather-related losses and significantly adverse experience in the mortgage and financial guaranty sectors. Due to the impact of mortgage and financial guarantee losses, the projected industry combined ratio for 2008 is 104%. Without this segment, a 101.2% combined ratio would have been achieved. Due to limited catastrophe losses and the positive effect of reserve releases, the industry combined ratio for 2007 was 97.5%.
Net realized investment losses, net of tax, reduced return on average equity by 2.9% and 4.6% for the years ended December 31, 2008 and 2007, respectively.
Net investment income and realized gains (losses). Net investment income decreased due to a decrease in investment yields, particularly yields on mortgage-backed securities. Total invested assets, including cash and cash equivalents, were approximately the same at $677.2 million and $696.8 million for 2008 and 2007, respectively. Net cash flows provided by operations was $61.7 million in 2008. On a tax equivalent basis, the book yield was 4.6% as of December 31, 2008 and 5.6% as of December 31, 2007.
Total revenues. Total revenues increased by 37.5% to $411.6 million for 2007 compared to $299.3 million for 2006. The increase is primarily due to the increase in earned premiums, total commission and fee income and net investment income, offset by net realized investment losses. The acquisition of Preserver added $59.4 million to total revenues in 2007. Gross premiums earned increased by 43.6% to $521.9 million for 2007 compared to $363.4 million in 2006 partly due to the acquisition of Preserver, which added $63.6 million in gross premiums earned, and growth in our book of business. Total commission and fee income increased to $106.3 million in 2007 compared to $52.2 million in 2006. An increase in both the quota share ceding percentage and commission on premiums produced by TRM contributed to this increase. Net investment income increased in 2007 primarily due to an increase in invested assets compared to 2006. Net realized investment losses were $17.5 million in 2007 compared to realized gains of $12,000 in 2006. The losses in 2007 were due to the sale of various residential mortgage-backed securities and recognition of $10.1 million in OTTI.
Ceded premiums earned increased by 11.9% as a result of the increase in traditional and specialty program ceded premiums earned during the year. The increase was offset by a reduction in ceded premiums earned on brokerage business resulting from the aforementioned changes in the cession rate.
The aggregate fair value of our invested assets as of December 31, 2008 was $541.0 million. Our fixed maturity securities as of this date had a fair value of $530.2 million and an amortized cost of $581.5 million. Equity securities carried at fair value were $10.8 million with a cost of $12.7 million as of December 31, 2008.
As disclosed in Note 5 to the Consolidated Financial Statements, “Fair Value Measurements,” effective January 1, 2008, we adopted SFAS No. 157, which provides a revised definition of fair value, establishes a framework for measuring fair value and expands financial statements disclosure requirements for fair value. Under SFAS No. 157, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (an “exit price”). The statement establishes a fair value hierarchy that distinguishes between inputs based on market data from independent sources (“observable inputs”) and a reporting entity’s internal assumptions based upon the best information available when external market data is limited or unavailable (“unobservable inputs”). The fair value hierarchy in SFAS No. 157 prioritizes fair value measurements into three levels based on the nature of the inputs. Quoted prices in active markets for identical assets have the highest priority (“Level 1”), followed by observable inputs other than quoted prices including prices for similar but not identical assets or liabilities
The following tables show the fair value and unrealized loss by credit quality rating and deal origination year of our commercial, residential non-agency-backed and asset-backed securities at December 31, 2008:
The cash equivalents at December 2008 were higher than historical amounts as a result of the building up our cash balances as we reassess our investment policies and seek to maintain a higher level of liquidity due to current market conditions.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements-an amendment of ARB No. 51” (“SFAS No. 160”). This standard establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. The guidance will become effective as of the beginning of the Company’s fiscal year beginning after December 15, 2008. The Company expects to adopt SFAS no. 160 on January 1, 2009 and does not expect the adoption to have a material effect on its consolidated financial condition or results of operations.
The Company accounts for costs incurred to develop computer software for internal use in accordance with Statement of Position (SOP) 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.” As required by SOP 98-1, the Company capitalizes the costs incurred during the application development stage, which include costs to design the software configuration and interfaces, coding, installation, and testing. Costs incurred during the preliminary project along with post-implementation stages of internal use computer software are expensed as incurred. Capitalized development costs are amortized over various periods up to three years. Costs incurred to maintain existing product offerings are expensed as incurred. The capitalization and ongoing assessment of recoverability of development costs requires considerable judgment by management with respect to certain external factors, including, but not limited to, technological and economic feasibility, and estimated economic life. For the years ended December 31, 2008
Incurred losses and LAE are net of reinsurance recoveries under reinsurance contracts of $125.6, $106.8 million, and $64.7 million in 2008, 2007, and 2006, respectively.
Since the weighted-average shares for the quarters are calculated independently of the weighted-average shares for the year, quarterly earnings per share may not total to annual earnings per share. In addition, preferred dividends are excluded from the quarterly calculations of earnings per share in 2007 and 2006 since they are anti-dilutive, but are included in the year end calculations.