** 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.
In Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A), the general financial condition and results of operations for the Company are discussed. The most important points discussed in the MD&A report are summarized below.
o The Company continues to have an adequate margin of solvency. On December 31, 2003 the margin was $20.1 million.
o Incurred loss ratios have continued to improve in 2003. The incurred loss ratio for the year ended December 31, 2003 was of 64.7% compared to 71.6% and 73.4% in 2002 and 2001, respectively. Combined ratios (incurred losses and expenses divided by earned premiums) have also continued to improve. The combined ratio of 90.5% in 2003 represents an improvement over the combined ratio of 98.1% in 2002 and 100.8% in 2001.
o Improved underwriting results and efficiencies in the payment of claims have allowed the Company to reduce the factor used to calculate reserves for unpaid losses by 10 percentage points during 2003. This resulted in a favorable earnings impact for the Company of approximately $1.1 million.
o The Company's investment in a global equity fund returned to an unrealized gain position during 2003. At December 31, 2003 this investment was in a $1.3 million unrealized gain position. This represents a significant improvement from the unrealized loss position of this investment at December 31, 2002 of $3.8 million.
o With the approval of MIC, the Company established a trust account to collateralize amounts recoverable from the Company related to business ceded to it. The trust account arrangement replaces the letters of credit that were previously in place between the Company and MIC.
The Company's financial statements have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). The preparation of our financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the amounts of assets and liabilities and disclosures of assets and liabilities reported by us at the date of the financial statements and the revenues and expenses reported during the reporting period. As additional information becomes available or actual amounts become determinable, the recorded estimates may be revised and reflected in operating results. Actual results could differ from those estimates. Accounts that, in our judgment, are most critical to the preparation of our financial statements include policy liabilities and accruals, deferred policy acquisition costs and valuation of certain investments.
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
Reinsurance premiums are based on the Company assuming (after ceding commission) 75% of the original net policy premiums written by the direct insurer prior to October 1, 2001 and 80% for net policy premiums written by the direct insurer on and after October 1, 2001. Of these premiums, 75% is retroceded to the Company when such premiums are written and the remaining 25% is retroceded when such premiums are earned (net of ceding commissions and excise taxes).
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 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 2004 and in future years to which its reinsurance liabilities extend. No significant capital expenditures are expected in the foreseeable future.
In March of 2004, the Board of Directors authorized the payment of dividends aggregating $8,022,359 to eligible holders of Shares. See "Market for Registrant's Common Equity and Related Stockholders Matters" for a discussion of dividends paid and legal restrictions on the payment of dividends.
The decrease in unearned premium reserves as of December 31, 2003 compared to December 31, 2002 is primarily attributable to certain series of Shares being placed into "run-off" and their subsequent redemption after the underlying policies reach a fully-earned status. When a series of Shares is placed into run-off, the Company discontinues assuming any additional risk and stops receiving premiums with respect to mechanical motor vehicle service contracts that are sold after the date that the series is placed into run-off by the Franchise(s) with respect to which the series of Shares is issued. When a series is placed into run-off, the premium that had been previously ceded to the Company that is attributable to such series of Shares continues to earn out and the unearned premium reserve decreases. As of December 31, 2003, 93 series of Shares were in run-off compared to 119 series as of December 31, 2002.
Capitalization of the Company, as of December 31, 2003, was comprised of paid-in capital with respect to the Common Stock of $200,000 (compared to $200,000 at both December 31, 2002 and 2001), paid-in capital with respect to the Shares of $1,545,000 (compared with $1,747,500 and $1,875,000 as of December 31, 2002 and 2001, respectively), and earnings retained for use in the business of $23,411,660 (compared with $20,276,888 and $18,521,974 as of December 31, 2002 and 2001, respectively). The reduction in the amount of paid-in capital with respect to the Shares as of December 31, 2003 compared with December 31, 2002 is primarily attributable to the redemption of Shares in run-off that have reached a fully earned status. There were a total of 206 series outstanding at December 31, 2003 compared to 233 and 250 series of Shares outstanding at December 31, 2002 and 2001, respectively. During 2003, the Company issued no new series of Shares and redeemed 27 series of Shares for a net decrease of 27 series. During 2002, the Company issued 2 new series of Shares and redeemed 19 series of Shares for a net decrease of 17 series.
The Company had net underwriting income (net income less investment income) of $4,307,205 in 2003 compared to net underwriting income of $956,765 and a net underwriting loss of $419,846 in 2002 and 2001, respectively. This gain was largely due to the absence of the earnings drag due to the earn-out and redemption of unprofitable series and due to efforts undertaken by the ceding company to control losses with respect to Shares. During 2003, the Company earned premiums of $45,407,270 compared to $49,812,496 and $53,412,569 during 2002 and 2001, respectively. Premium income decreased in both 2003 and 2002 compared to the prior year primarily as a result of fewer dealerships writing vehicle service contracts that are ceded to the Company, which is attributable to the redemption of additional series of Shares during the years ended December 31, 2003 and 2002, and the placement of certain series of Shares into run-off as previously discussed. This resulted in the Company assuming less business.
The Company incurred underwriting and administrative expenses during the year ended December 31, 2003 of $41,100,065 compared with $48,855,731 and $53,832,415 for the years ended December 31, 2002 and 2001, respectively. Expenses in 2003 were comprised of losses paid and provisions for loss reserves, ceding commissions and excise taxes totaling $40,352,451. Losses incurred in 2003 were $29,369,232 compared to $35,671,233 and $39,224,574 in 2002 and 2001, respectively. The incurred loss ratio for the year ended December 31, 2003 was 64.7% compared to 71.6% and 73.4% for the years ended December 31, 2002 and 2001, respectively. These
decreases in losses incurred and loss ratios are primarily attributable to the ongoing efforts by MIC to improve underwriting results and the earn-out and redemption of Shares, of which some have produced unprofitable business. Despite efforts by MIC to identify ways to improve underwriting results, there can be no assurances that the Company will not experience significant adverse underwriting results in the future and there can be no assurances that MIC would recapture any business from the Company if the Company does experience significant adverse underwriting results.
Based on market values at December 31, 2003, approximately 21% (2002-14%; 2001-18%) of the Company's investment portfolio was invested in a U.S. dollar denominated international equity fund and the remaining 79% (2002-86%; 2001-82%) was invested in U.S. dollar denominated fixed-income securities.
During 2003, the Company recorded a $18,741 impairment loss for its holding of one fixed income investment and no realized gains or losses for other than temporary impairment for its equity investments. This compares to $159,632 and $0 for the years ended December 31, 2002 and 2001, respectively. To determine whether an amount needed to be recorded for other than temporary impairment for its fixed income investments held, the Company evaluated, among other things, the length of time and the extent that the security's market value has been valued at less than cost; the financial health of the issuer, including any specific events which may influence the issuer; the Company's intent and ability to hold the investment; and the security's rating as determined by an independent rating agency. If an investment's unrealized loss position were to be determined to be other than temporary in
nature, the underlying security's cost basis would be written down to the market value at the time that the impairment charge was recorded.
To the extent the Fund was in an unrealized loss position during 2003, the Company's investment in the Fund was reviewed using the applicable criteria described above and such review also included the following procedures to determine whether any charge for other than temporary impairment was necessary:
o Reviewed the volatility of the Fund to determine if there has been a demonstrated ability for it to recover from an unrealized loss position.
As of December 31, 2003, the Company's fixed income portfolio was in an unrealized gain position of $0.9 million and its equity investment in the Fund was in an unrealized gain position of $1.3 million or 8% of its historical cost. No writedown for other than temporary impairment was recorded for the year ended December 31, 2003, except for the $18,741 noted above.
The fair value of the Company's investments that are in an unrealized loss position at December 31, 2003 are as follows:
Fixed Income Securities U.S. Government Agencies & Asset Backed 16,371.6 16,018.3 (353.3) (2.2)%
Corporate Asset Backed 4,204.5 4,092.5 (112.0) (2.7)% --------- --------- ------- Total-Fixed Income Securities $24,308.6 $23,787.2 $(521.4) (2.1)% ========= ========= =======
At December 31, 2003, the Company's investments are concentrated in the following industries:
The Company 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 were assigned to collateralize the letter of credit. At December 31, 2002, the fair value of such assets was $87,829,960 ($91,365,560 at December 31, 2001).
o Loss development factors were set equal to the weighted 12 month averages in order to smooth the effects of seasonality, while still reflecting the reductions due to efficiencies gained in the claims payment process that have been realized over the past several years. Such efficiencies resulted in the quicker payment of claims, resulting in fewer open claims at a given point in time.
As a result of change in estimates of losses incurred in prior years, the provisions for losses incurred in 2003, 2002 and 2001 decreased by $1,429,368, $1,347,207, and $1,304,766, respectively. The decreases are largely due to the efficiencies realized in the claims payment processes previously discussed and due to the decreasing number of policies in force as a result of fewer Shares outstanding.
The following table sets forth the development of losses and loss adjustment expenses from January 1, 1999 through December 31, 2003.
Year Ended -------------------------------------------------------- 12/31/99 12/31/00 12/31/01 12/31/02 12/31/03 -------- -------- -------- -------- -------- Liability for unpaid claims and claims adjustment expense... $4,725,239 $4,754,710 $3,949,590 $3,650,641 $2,164,872 ---------- ---------- ---------- ---------- ---------- Paid (cumulative) in subsequent year(s)... 3,835,555 3,439,444 2,592,679 2,078,702 Estimated unpaid liability as of year end*............ 12,639 10,500 9,704 142,571 --------- ---------- ---------- ---------- Cumulative Redundancy $ 877,045 $1,304,766 $1,347,207 $1,429,368 ========= ========== ========== ==========
The Policies reinsured by the Company are written for multiple years (up to seven years) and losses do not occur equally over the period for which the Policies are written, but tend to be clustered in the later years. Therefore, loss experience for prior years may not be indicative of that for future years.
Statements of Operations and Retained Earnings for the years ended December 31, 2003, 2002 and 2001 26
We have audited the accompanying balance sheets of Motors Mechanical Reinsurance Company, Limited (the "Company") as of December 31, 2003 and 2002, and the related statements of operations and retained earnings, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 2003 (expressed in United States dollars). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, such financial statements present fairly, in all material respects, the financial position of Motors Mechanical Reinsurance Company, Limited as of December 31, 2003 and 2002, and the results of its operations, changes in stockholders' equity and its cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America.
LIABILITIES Unearned premiums 76,246,766 83,482,170 Reserves for unpaid losses 4 2,164,872 3,650,641 Accrued liabilities 174,456 180,205 Due to Motors Insurance Corporation 805,718 - ----------- ----------- Total Liabilities 79,391,812 87,313,016 ----------- -----------
EXPENSES Acquisition costs 10,983,219 12,508,680 13,858,660 Losses paid 30,855,001 35,970,182 40,029,694 Decrease in reserves for unpaid losses (1,485,769) (298,949) (805,120) Administrative expenses Related parties 277,310 273,361 273,592 Other 470,304 402,457 475,589 ----------- ----------- -----------
RETAINED EARNINGS, end of year $23,411,660 $20,276,888 $18,521,974 =========== =========== ===========
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (CONTINUED)
RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY/(USED IN) OPERATING ACTIVITIES:
The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Reinsurance premiums are based on the Company assuming (after ceding commission) 75% of the original net policy premiums written by the direct insurer prior to October 1, 2001 and 80% for net policy premiums written by the direct insurer, on and after October 1, 2001. Of these net 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).
1. 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. 2. Reviewed the volatility of the Fund to determine if there has been a demonstrated ability for it to recover from an unrealized loss position. 3. Examined the concentration of the Fund from a geographical, industry, and individual security standpoint.
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.
The cost and fair value of investments in debt securities and equities are as follows:
Due within one year $ 50,148 $ 50,360 Due after five years through ten years 27,399,123 27,942,835 Due after ten years through thirty years 18,749,477 18,746,659 ------------- ------------- $ 64,959,519 $ 65,807,414 ============= =============
As a result, of change in estimates of losses incurred in prior years, the provisions for losses incurred in 2003, 2002, and 2001 decreased by $1,429,368, $1,347,207, and $1,304,766, respectively.
The Company utilizes a percentage of earned premiums for the corresponding quarter to estimate reserves for unpaid losses. The factor utilized is influenced by, among other things, underwriting performances and the ability of eligible participants to submit claim payments without requiring the pre-approval by an adjuster. As a result of improved underwriting performance and the utilization of those types of claim processes, the factor used in estimating reserves for unpaid losses at December 31, 2003 was 10 percentage points (or 33%) lower than that used at December 31, 2002 and 2001. During 2003, the factor was lowered by 5 percentage points in both the 2nd and 4th quarters. The factor changes resulted in a favorable earnings impact of $1,082,794 in 2003.
All of the Company's Common Stock is held by GMAC Insurance Holdings, Inc. Prior to December 2002, the Company's Common Stock was owned by MIC.
During year 2003, no additional series of 100 shares of Participating Stock were issued as compared to two series of 100 shares for the year ended December 31, 2002. In addition, during 2003 the Board of Directors ("the Board") redeemed twenty-seven series of 100 shares which had been previously placed in run-off (of which eleven had reached a fully earned position during 2003 and sixteen were redeemed for nil value). During 2002, the Board redeemed eighteen series of 100 shares of all which had been previously placed in run-off and had reached fully earned position. In addition, the Board redeemed one series of 100 shares for $230,538, which represented the balance in the capital and surplus account at July 1, 2002. Also, MIC recaptured the unearned premiums and loss reserves for this series (see Note 9).
In the years ended, December 31, 2003, 2002, and 2001 costs in the amount of $141,229, $90,753 and $106,751, respectively, were incurred in the sale of Participating Stock. MIC reimburses the Company directly for these expenses. Such reimbursements are deducted from the gross administrative expenses of the Company.
The holders of Participating Stock as a class are entitled to elect one director. Generally, liquidation of the Company requires approval by at least 75% of the outstanding shares of this class. Any redemption of a series of shares requires a vote of the Board of Directors, provided that the director representing holders of the Participating Stock votes in favor of the redemption. Any changes in the Company's Articles of Incorporation or By-Laws require the approval of a majority of the shares of Participating Stock present and voting together with a majority of the shares of Common Stock.
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, 2003 and 2002, there were no funds held in escrow.
On December 22, 2003, the Company entered a trust agreement with MIC, which requires assets to be held in a regulated trust account to collateralize the amounts recoverable from the Company related to the business ceded to it. The amount required at December 31, 2003 was $62,025,054 ($0 at December 31, 2002). Cash equivalents and investments are deposited in the trust account. At December 31, 2003 the fair value of such assets was $88,911,501 ($0 at December 31, 2002).
The Company 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 were 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 31, 2001).
i) the Company meets Barbados' regulatory requirement without regard to any letter of credit or guarantee; and ii) the related subsidiary capital account meets those requirements after giving effect to the dividend.
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, 2004, the Company's required minimum margin of solvency computed in accordance with Barbados law was $5,040,727.
On March 3, 2004 the Company's Board of Directors declared a dividend in the amount of $8,022,359 to eligible Participating Stockholders on record as of December 31, 2003.