The preparation of the Company’s financial statements requires judgment and estimates. The most significant is the estimate of loss reserves as required by Statement of Financial Accounting Standards No. 60, “Accounting and Reporting by Insurance Enterprises” (“SFAS No. 60”) and Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies” (“SFAS No. 5”). Estimating loss reserves is a difficult process as there are many factors that can ultimately affect the final settlement of a claim and, therefore, the reserve that is needed. Changes in the regulatory and legal environment, results of litigation, medical costs, the cost of repair materials and labor rates can all impact ultimate claim costs. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of the claim, the more variable the ultimate settlement amount can be. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably predictable than long-tail liability claims. Inflation is reflected in the reserving process through analysis of cost trends and reviews of historical reserving results. Management believes that the liability for losses and loss adjustment expenses is adequate to cover the ultimate net cost of losses and loss adjustment expenses incurred to date. Since the provisions are necessarily based upon estimates, the ultimate liability may be more or less than such provision.
Premiums earned in 2001 of $1,380.6 million increased 10.5% and net premiums written in 2001 of $1,442.9 million increased 13.4% over amounts recorded in 2000. Contributing to the overall premium written growth were increased policy sales in the California automobile insurance lines as well as increased production in California homeowners insurance, Florida automobile insurance and Texas automobile insurance.
Total losses and expenses in 2001, excluding interest expense of $7.7 million, were $1,374.4 million, resulting in an underwriting gain (premiums earned less total losses and expenses excluding interest) for the period of $6.1 million compared with an underwriting gain of $19.1 million in 2000.
As of December 31, 2002, the average Standard & Poor’s rating of the $1,551.6 million bond portfolio (at amortized cost) was AA, while the average effective maturity, giving effect to anticipated early call provisions, approximates 5.7 years. The modified duration of the bond portfolio at year-end was 4.4 years which includes collateralized mortgage obligations and short term cash investments. Modified duration measures the length of time it takes, on average, to receive the present value of all cash flows produced by a bond, including reinvestment of interest income. Because it measures four factors (maturity, coupon rate, yield and call terms) which determine sensitivity to changes in interest rates, modified duration is considered a much better indicator of price volatility than simple maturity alone. Municipal bond holdings are broadly diversified geographically and by obligor. Traditionally, it has been the Company’s policy not to invest in high yield or “junk” bonds. At December 31, 2002, bond holdings rated below investment grade totaled $50.1 million at market (cost $68.8 million), or less than 2% of total assets. An increase in the portfolio’s average rating from A at December 31, 2001 to AA at December 31, 2002 reflects a larger percentage of the portfolio invested in higher rated municipal bonds and collateralized mortgage obligations while divesting lower rated corporate bonds.
In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections” (“SFAS No. 145”). The objectives of SFAS No. 145 are to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS No. 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The provisions of SFAS No. 145 related to the rescission of Statement 4 are applicable to fiscal years beginning after May 15, 2002. The provisions related to Statement 13 are applicable to transactions occurring