Liquidity. 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, 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. Although losses are expected to increase due to the increased level of premiums assumed in each preceding year and the anticipated incidence of claims following the expiration of manufacturers' warranties, available funds from the sources identified above have also grown. Net cash provided by operating activities has decreased to $16,077,051 in 1998 from $17,304,385 in 1997 and $17,588,199 in 1996. The Company believes that such funds will be sufficient to meet its liquidity requirements in 1999 and in future years to which its reinsurance liabilities extend. No capital expenditures are expected during the next few years.
The Company had unearned premium reserves of $110,243,074 as of December 31, 1998, and $95,454,588 as of December 31, 1997. These amounts are attributable to the long-term nature of the contracts sold. Such contracts may extend for up to 72 months from date of issue. In addition, the risk of loss to the Company under the contract arises primarily after the underlying manufacturer's warranty expires. For new vehicles, the warranty generally covers 36 months or 36,000 miles. For used vehicles, the applicable warranty period depends on the unexpired portion of the original manufacturer's warranty at the time of purchase of the vehicle. Because the Company has limited exposure to risk of loss prior to expiration of the underlying manufacturer's warranty, most premium is not recognized as earned until such expiration. Since very little premium is recognized as earned until the expiration of the underlying warranty, most of the premium written in any year is recorded as unearned.
Capital Resources. Capitalization of the Company, as of December 31, 1998, was comprised of paid-in capital with respect to the Common Stock of $200,000, paid-in capital with respect to the Shares of $2,362,500 (compared with $2,115,000 and $1,905,000 as of December 31, 1997 and 1996, respectively), and earnings retained for use in the business of $20,629,009. 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, 1999, the Company's required minimum net assets computed in accordance with Barbados law was approximately $6,284,567, compared to total capital and retained earnings computed for purposes of Barbados law of $23,191,509.
The sale of investment securities for the year ended December 31, 1998 resulted in realized gains of $4,404,651 compared to realized gains of $750,923 and $64,244 for the years ended December 31, 1997 and 1996, respectively. The increases in realized gains during the year under review arose primarily as a result of increased sales of investment securities to take advantage of market opportunities presented by uncertainty in the U.S. dollar denominated international equity markets. Interest earned for the year ended December 31, 1998 was $5,970,813 compared to $4,953,755 and $5,277,680 for the years ended December 31, 1997 and 1996, respectively. The increase in interest earned during 1998 compared to 1997 was largely a result of an increase in the amount of assets under management combined with a slight increase in the overall rate of return. The decrease from 1996 compared to 1997 resulted from lower available yields.
Unrealized appreciation on investment securities held at December 31, 1998 was $334,059 compared to unrealized appreciation at December 31, 1997 of $1,135,201. The decrease in unrealized appreciation as of December 31, 1998 compared to December 31, 1997 resulted from sales of investment securities during the third and fourth quarters of 1998 to take advantage of market conditions.
Although at December 31, 1998 and 1997, 100% of the Company's investments were in U.S. dollar-denominated fixed-income securities, the Company's fixed income investment manager seeks on occasion to identify non-U.S. dollar-denominated investments that offer a higher rate of return (net of currency hedging costs) than would be available in the market for similarly rated U.S. dollar-denominated bonds. Instruments used to hedge non-U.S. dollar-denominated investments involve, to varying degrees, elements of credit risk in the event a counterparty should default on its obligation under the hedge instrument. Such credit risk is managed through the selection of financially sound counterparties and periodic monitoring of counterparty financial condition. The Company's investment guidelines do not permit the use of derivatives in managing interest rate risk.
In June 1997, the Financial Accounting Standards Board ("FASB") issued a Statement of Financial Accounting Standards ("FASB") No. 130, Reporting Comprehensive Income, effective for fiscal years beginning after December 15, 1997. Under this statement all items required to be recognized under accounting standards as components of comprehensive income must be reported in a financial statement that is displayed with the same prominence as other financial statements. The Company has adopted this accounting standard in 1998. Adopting the accounting standard has no impact on reported net income of the Company.
We have audited the accompanying balance sheets of Motors Mechanical Reinsurance Company, Limited as of December 31, 1998 and 1997 and the related statements of income and retained earnings, and cash flows and changes for each of the three years in the period ended December 31, 1998. 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.
MOTORS MECHANICAL REINSURANCE COMPANY, LIMITED BALANCE SHEETS DECEMBER 31, 1998 AND 1997
MOTORS MECHANICAL REINSURANCE COMPANY, LIMITED NOTES TO THE FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
Investments, all of which are available for sale, are comprised of interest-bearing marketable securities 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. Unrealised appreciation (depreciation) is included in accumulated other comprehensive income.
The cost and fair value of investments in debt securities are as follows:
Cost Fair Value Due after one year through five years $58,087,649 $57,989,686
Due after five years through ten years 31,052,669 31,484,691 ----------- -----------
In 1998, gross gains of $6,253,358 and gross losses of $1,848,707 were realized. In 1997, gross gains of $1,494,878 and gross losses of $743,955 were realized. In 1996, gross gains of $1,997,197 and gross losses of $1,932,953 were realized.
During 1998, 37 additional series of 100 shares of Participating Stock were issued as compared with 29 for the year ended December 31, 1997. In addition, in 1998 the Board of Directors redeemed 4 series of 100 shares at the request of the shareholders. The redeemed series had been previously placed in run off and had reached a fully earned position during 1998.
Common Participating Total ----------- ------------- ----------- Balance (Deficit), December 31, 1995 $ (10,861) $11,528,403 $11,517,542