Underwriting expenses increased by 36.4% to $621.7 million in 2002 from $455.7 million in 2001. Commission, brokerage, taxes and fees increased by $155.0 million, principally reflecting increases in premium volume and changes in the mix of business. Other underwriting expenses increased by $11.0 million as the Company expanded its operations to support its increased business volume. Contributing to the underwriting expense increase were a 95.6% ($4.0 million) increase in the Bermuda operation, a 79.7% ($65.9 million) increase in the U.S. Insurance operation, a 31.9% ($29.8 million) increase in the International operation, a 27.0% ($29.1 million) increase in the Specialty operation and a 22.8% ($37.4 million) increase in the U.S. Reinsurance operation. The changes for each operation's expenses principally resulted from changes in commission expenses related to changes in premium volume and business mix by class and type and, in some cases, the underwriting performance of the underlying business. The Company's expense ratio, which is calculated by dividing underwriting expenses by premiums earned, decreased by 3.8 percentage points to 27.3% in 2002 compared to 31.1% in 2001.
Ceded premiums increased to $314.5 million in 2001 from $166.7 million in 2000. This increase was principally attributable to $81.3 million of adjustment premiums incurred under the 2001 accident year aggregate excess of loss element of the Company's corporate retrocessional program relating to losses incurred as a result of the September 11 attacks and the Enron bankruptcy. In addition, ceded premiums for 2001 and 2000 also include adjustment premiums of $58.1 million and $35.2 million, respectively, relating to claims made under the 1999 accident year aggregate excess of loss element of the Company's corporate retrocessional program. The increase in ceded premiums in 2001 also reflects the impact on the U.S. Insurance operation's specific reinsurance protections resulting from this segment's volume increase.
PREMIUMS WRITTEN AND EARNED. Premiums written by the Company are earned ratably over the periods of the related insurance and reinsurance contracts or policies. Unearned premium reserves are established to cover the remainder of the unexpired contract period. Such reserves are established based upon reports received from ceding companies or computed using pro rata methods based on statistical data. Written and earned premiums, and the related costs, which have not yet been reported to the Company are estimated and accrued. As earned premium generally correlates with the Company's estimate of its exposure base, variations in premium earnings are to a large degree offset by related variability in incurred losses and commission expense. See also Footnote 1 to Notes to the Consolidated Financial Statements.
The tables below display the potential impact of a parallel 20% increase and decrease in foreign exchange rates on the valuation of invested assets subject to foreign currency exposure in 10% increments as of December 31, 2002 and 2001. This analysis includes the after-tax impact of translation from transactional currency to functional currency as well as the after-tax impact of translation from functional currency to the U.S. dollar reporting currency. All amounts are in U.S. dollars and are presented in millions.
As there is no active market for these instruments, the determination of their fair value is based on an industry accepted option pricing model which requires estimates and assumptions, including those regarding volatility and expected rates of return. The table below estimates the impact of potential movements in interest rates and the S&P 500 index, which are the principal factors affecting fair value of these instruments, looking forward from the fair value at December 31, 2002. These are estimates and there can be no assurances regarding future market performance.
The Company is subject to extensive regulation under U.S., state and foreign insurance laws. These laws limit the amount of dividends that can be paid to the Company by its operating subsidiaries, impose restrictions on the amount and type of investments that they can hold, prescribe solvency standards that must be met and maintained by them and require them to maintain reserves. These laws also require disclosure of material intercompany transactions and require prior approval of certain "extraordinary" transactions. These "extraordinary" transactions include declaring dividends from operating subsidiaries that exceed statutory thresholds. These laws also generally require approval of changes of control. The Company's failure to comply with these laws could subject it to
GROUP AND/OR BERMUDA RE MAY BECOME SUBJECT TO BERMUDA TAX, WHICH WOULD REDUCE THE COMPANY'S NET INCOME.