** In 2002 and 1999, MIC recaptured certain insurance business that had been previously ceded to the Company. See Note 9 to the Financial Statements and "Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations."
Realized gains and losses on the sale of investments and losses from other than temporary impairment are included as investment income and are calculated based on amortized costs. To evaluate whether any investments require provision for other than temporary impairment, the Company evaluated, among other things, the length of time and the extent that a security's market value was below cost; the financial strength of the issuer, including any specific events that may influence the issuer; the Company's intent to hold the investment; the geographical and industry concentration of securities held; and the security's rating as determined by an independent rating agency. In addition, the Company evaluated whether the underlying security has demonstrated an ability to recover from unrealized loss positions in the past.
Reinsurance premiums are based on the Company assuming (after ceding commission) 75% of the original policy premiums written by the direct insurer prior to October 1, 2001 and 80% for policy premiums written by the direct insurer on and after October 1, 2001. Of these premiums, 75% is retroceded to the Company when written and the remaining 25% is retroceded when such premiums are earned (net of ceding commissions and excise taxes).
The liability for unpaid losses and loss expenses represents the accumulation of estimates for reported losses and a provision for losses incurred but not reported, including claim adjustment expenses. For purposes of establishing reserves for unpaid losses, the Company relies upon the advice of MIC. Loss reserve projections are used to estimate loss reporting patterns, loss payment patterns, and ultimate claim costs. An inherent assumption in such projections is that historical patterns can be used to predict future patterns with reasonable accuracy. Because many variables can affect past and future loss patterns, the effect of changes in such variables on the results of loss projections must be carefully evaluated. The evaluation of these factors involves complex, subjective judgments, which may significantly impact the financial statements. Insurance liabilities are, therefore, necessarily based on estimates, and the ultimate liability may vary from such estimates. Establishing reserves is an uncertain process, and it is possible that actual claims will materially exceed reserves and have a material adverse effect on our results of operations and financial condition. These estimates are regularly reviewed by management and adjustments to such estimates are included in income on a current basis. See Note 4 to the Financial Statements.
The Company expects to generate sufficient funds from operations to cover current liquidity needs. The Company's liquidity requirements are related to payment of insurance losses, administrative expenses, redemptions of Shares, and dividends. Premiums generated by the Company's reinsurance business, combined with investment earnings plus proceeds from the sale of Shares, will continue to be the principal sources of funds for the Company. The Company believes that such funds will be sufficient to meet its liquidity requirements in 2003 and in future years to which its reinsurance liabilities extend. No significant capital expenditures are expected in the foreseeable future.
Barbados law requires that the Company's net assets equal at least the aggregate of $1,000,000 and 10% of the amount by which the earned premium exceeded $5,000,000 in the previous year. If the Company's net assets are less than mandated by Barbados law, the Company has the right to reduce the business related to a Subsidiary Capital Account by retrocession or any other means to the extent necessary to permit the Subsidiary Capital Account to meet its pro rata share of the Company's required capital and surplus. At January 1, 2003, the Company's required minimum net assets computed in accordance with Barbados law was $5,481,250 compared to total capital and retained earnings computed for purpose of Barbados law of $22,224,388.
o Reviewed the relationship between the Fund's market value compared to its historical cost since its purchase. This included examining the period of time that the Fund was consecutively in an unrecognized loss position.
There are inherent uncertainties in applying methodology and procedures described above with the primary uncertainty being the continued instability in most international economies, geographic regions, and industries in which the Fund invests. Should management determine in the future that a decline in the value of any of its investment portfolio is other than temporary, the overall impact on the Company's holdings of fixed income investments and its investment in the Fund is estimated to be a gross loss of $0.03 million and $3.8 million, respectively. This represents the gross unrealized loss position at December 31, 2002 of the Company's fixed income and equity portfolio, respectively.
All of the fixed income securities included in the above table are considered investment grade and have maturity dates ranging from January 2003 to June 2031. Excluding the securities shown in detail, the Company held positions in ten fixed income securities with an unrealized loss ranging from approximately $1,000 to $11,300 (or between 0.0% and 2.2% of cost) at December 31, 2002. Of the above, only one security was in an unrealized loss position for over 12 consecutive months; however, its unrealized loss position was $11,400 or 2.2% of its cost at December 31, 2002. All of the other securities in an unrealized loss position at December 31, 2002 were in such a position for nine consecutive months or less.
At December 31, 2002, the Company's investments are concentrated in the following industries:
For purposes of establishing reserves for unpaid losses, the Company relies upon the advice of MIC. At December 31, 2002 and 2001, the Company's reserves for unpaid losses were calculated as a percentage of earned premiums for the corresponding quarter. This calculation is compared to an acceptable range for the reserves developed by actuaries of the ceding company. At December 31, 2002, and 2001, the reserves for unpaid losses were $3,650,641 and $3,949,590, respectively. At December 31, 2002, the estimated range of reserves for unpaid losses prepared for MMRC by the ceding company's actuaries was as follows:
Although the recorded reserves are slightly higher than the high-end of the range of estimated reserves, it is not considered material.
Reserves for unpaid losses are established after periodic actuarial reviews, based on judgments of the effects of technological change, manufacturers' warranties, and MIC's historical experience with mechanical motor vehicle service agreements. Consequently, the determination of reserves for unpaid losses is an estimate and a process inherently subject to a number of highly variable factors. Ultimate losses could exceed reserves for unpaid losses and cause us to have to adjust such reserves. Any adjustments to reserves for unpaid losses are reflected in the operating results for the periods in which they become known.
Had the current percentage of quarterly earned premiums been used for determining reserves for unpaid losses at December 31, 2000, the estimated reserve would have been $4.1 million, or $0.7 million lower than actually recorded. There have been no changes to the key assumptions made to estimate the reserves for unpaid losses nor has there been any changes as to the nature and timing of the changes, including new events that occurred since the last reporting date (December 31, 2001).
The Company's incurred loss ratios (losses incurred as a percentage of net premium earned) on all business for the years ended December 31, 2002, 2001 and 2000 were 71.6%, 73.4% and 74.9%, respectively.
The following table sets forth the development of losses and loss adjustment expenses from January 1, 1998 through December 31, 2002.
* Mechanical breakdown claims are generally paid within 90 days of when they are incurred. Accordingly, the liability for unpaid claims incurred in all prior years has been combined at each year end. At December 31, 1998, the estimated unpaid liability was significantly higher due to a claim cycle prior to December 31 not being processed as scheduled.
The table above shows initial estimated reserves at December 31, 2002, 2001, 2000, 1999 and 1998 and amounts paid on claims unsettled at each prior period end. Claims are typically processed for payment at the time the claim is reported. Therefore, the recorded claim liability at each year end represents the estimated incurred, but not reported claims and claims in the process of payment. The cumulative deficiency or redundancy represents the total change in reserve estimates covering prior years.
FASB Interpretation No. 45, "Guarantor Accounting," will significantly change current practice in the accounting for, and disclosure of, guarantees. Most guarantees are to be recognized and initially measured at fair value, which is a change from current practice. In addition, guarantors will be required to make significant new disclosures, even when the likelihood of the guarantor making payments under the guarantee is remote. In general, the Interpretation applies to contracts or indemnification agreements that contingently require the guarantor to make payments to the guaranteed party based on changes in an underlying agreement that is related to an asset, liability, or an equity security of the guaranteed party. The Interpretation's disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002, while the initial recognition and initial measurement provisions are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. We do not believe the adoption of this statement will have a material impact on the Company's results of operations or financial position. Guarantees issued by reinsurance companies accounted for under SFAS No. 113 are not within the scope of FASB Interpretation No. 45, which reduces the potential impact this could have on the Company.
Statements of Operations and Retained Earnings for the years ended December 31, 2002, 2001 and 2000 28
Statements of Changes in Stockholders' Equity for the years ended December 31, 2002, 2001 and 2000 29
The Company is incorporated under the laws of Barbados and is a licensed insurer under the Exempt Insurance Act, 1983 and amendments thereto.
As of December 2002, all of the common stock of the Company is owned by GMAC Insurance Holdings, Inc. ("GMACI"). Prior to that date, all of the common stock of the Company was owned by Motors Insurance Corporation ("MIC"), a wholly-owned subsidiary of GMACI. GMACI (the "common stockholder") is an indirect wholly-owned subsidiary of General Motors Corporation. The principal activity of the Company is the assumption of mechanical motor vehicle service agreements arising under insurance policies reinsured by MIC and attributable to an MIC Mechanical Account in respect of which shares of Participating Stock are issued and outstanding. All premiums received were assumed from MIC.
Certain amounts from 2000 and 2001 have been reclassified to conform with 2002 classification.
Reinsurance premiums are based on the Company assuming (after ceding commission) 75% of the original policy premiums written by the direct insurer prior to October 1, 2001 and 80% for policy premiums written by the direct insurer, on and after October 1, 2001. Of these reinsurance premiums, 75% is retroceded to the Company when written and the remaining 25% when such premiums are earned (net of ceding commissions and excise taxes).
Investments, all of which are available for sale, are comprised of interest-bearing marketable securities, and an investment in an international equity fund (the "Fund"), which are carried at fair value based on quoted market prices and dealer quotes obtained from an external pricing service. Investments with original maturities of less than 90 days are classified as cash equivalents. Unrealized appreciation (depreciation) is included in accumulated other comprehensive income (loss).
The Company received an undertaking from the Barbados Government exempting it from all local income, profits and capital gains taxes which expired on December 31, 2001. Beginning January 1, 2002, the Company is subject to tax at a rate of 2% on its taxable income provided that the amount of such tax will not exceed $2,500 per annum until December 31, 2016.
Stockholders who are United States residents are taxed in the United States on their share of the Company's income on an imputed basis.
Balance, December 31, 1999 $ (162,459) Net appreciation 2,894,882 --------------- Balance at December 31, 2000 $ 2,732,423 Net depreciation (963,375) --------------- Balance at December 31, 2001 $ 1,769,048 Net depreciation (2,926,956) --------------- Balance at December 31, 2002 $ (1,157,908) ===============
As a result, of change in estimates of losses incurred in prior years, the provisions for losses incurred in 2002, 2001, and 2000 decreased by $1,347,207, $1,304,766, and $877,045, respectively.
The Company utilizes a percentage of earned premiums for the corresponding quarter to calculate reserves for unpaid losses. The factor utilized is influenced by, among other things, the extent of utilizing electronic claim settlement processes and the ability of eligible participants to submit claim payments without requiring the pre-approval by an adjuster. At December 31, 2001 as a result of the increased utilization of such processes, the factor used to estimate reserves for unpaid losses was reduced. At December 31, 2002, the factor used was consistent with that used at December 31, 2001.
During year 2002, two additional series of 100 shares of Participating Stock were issued as compared to one series of 100 shares for the year ended December 31, 2001. In addition, during 2002 the Board of Directors (the "Board") redeemed eighteen series of 100 shares, which had been previously placed in run-off and had reached fully earned position during 2002. In addition, the Board redeemed one series of 100 shares for $230,538, which represents the balance in the capital and surplus account at July 1, 2002. Also, MIC recaptured the unearned premiums and loss reserves for the series (see Note 9). During 2001, the Board redeemed ten series of 100 shares, which had been previously placed in run-off which had reached a fully earned position during 2001.
From time to time, funds are held in escrow on account of Participating Stock applications. Such amounts are not included in cash and cash equivalents in the accompanying financial statements. At December 31, 2002 and 2001, there were no funds held in escrow.
The Company has provided an irrevocable letter of credit to MIC in the amount of $68,500,000 at December 31, 2002 ($72,350,000 at December 31, 2001) to collateralize the amounts recoverable from the Company related to the business ceded to it. Cash equivalents and investments are assigned to collateralize the letter of credit. At December 31, 2002 the fair value of such assets was $87,820,960 ($91,365,560 at December 2001).
Items of income or loss and premiums and expenses attributable to insurance underwriting activities are determined as of the end of each calendar quarter and are allocated to the Participating Stockholders' subsidiary capital accounts.
Dividends may be declared and paid at the discretion of the Company's Board of Directors, subject to the right of holders of Participating Stock to receive minimum dividends. The minimum annual dividend payable on each share shall be such share's pro-rata portion of an amount equal to twenty percent of the net income, if any, for the preceding year attributable to the subsidiary capital account associated with the series of which that share is part, provided:
i) the Company meets Barbados' regulatory requirement without regard to any letter of credit or guarantee; and
Barbados law requires that the Company maintain a minimum margin of solvency based generally on the amount of premiums earned in the preceding year. At January 1, 2003, the Company's required minimum margin of solvency computed in accordance with Barbados law was approximately $5,481,250.