The following selected financial data for the years ended December 31, 2002, 2001, 2000, 1999 and 1998 have been derived from the Company's audited financial statements.
* Information as to earnings per share is not provided inasmuch as the results for each series of stock will vary with the underwriting experience attributable to each Subsidiary Capital Account established with respect to that series. See Note 2 to the Financial Statements.
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.
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.
In 2002, the Board of Directors authorized the payment of dividends aggregating $4,318,225 to eligible holders of Shares. The Board of Directors expects to authorize the payment of dividends during the first half of 2003. 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 Company had unearned premium reserves of $83,482,170 as of December 31, 2002, compared to $89,634,122 as of December 31, 2001. Unearned premium amounts are attributable to the long-term nature of the service contracts sold. Such contracts may extend for up to 84 months from the 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 from the date that the vehicle is initially placed into service. 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 after such expiration. Since very little premium is recognized as earned until after the expiration of the underlying warranty, most of the premium written in any year is recorded as unearned.
The decrease in unearned premium reserves as of December 31, 2002 compared to December 31, 2001 is primarily attributable to the Company placing certain series of Shares 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 or receiving any 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, 2002, 117 series of Shares were in run-off compared to 132 series as of December 31, 2001.
Capitalization of the Company, as of December 31, 2002, was comprised of paid-in capital with respect to the Common Stock of $200,000 (compared to $200,000 at both December 31, 2001 and 2000), paid-in capital with respect to the Shares of $1,747,500 (compared with $1,875,000 and $1,942,500 as of December 31, 2001 and 2000, respectively), and earnings retained for use in the business of $20,276,888 (compared with $18,521,974 and $16,247,004 as of December 31, 2001 and 2000, respectively). The reduction in the amount of paid-in capital with respect to the Shares as of December 31, 2002 compared with December 31, 2001 is primarily attributable to the redemption of Shares in run-off that have reached a fully earned status. There were a total of 233 series outstanding at December 31, 2002 compared to 250 and 259 series of Shares outstanding at December 31, 2001 and 2000, respectively. During 2002, the Company issued 2 new series of Shares and redeemed 19 series of Shares for a net decrease of 17 series. During 2001, the Company issued 1 new series of Shares and redeemed 10 series for a net decrease of 9 series.
During the year ended December 31, 2002, the Company had net income of $7,325,118 compared to $5,730,918 for the year ended December 31, 2001 and of $3,678,373 for the year ended December 31, 2000. The increase in net income in 2002 compared to 2001 is attributable to an improvement in underwriting results combined with a $217,589 increase in investment income. The increase in net income in 2001 compared to 2000 is also attributable to an improvement in underwriting results combined with a $1,341,856 increase in investment income.
The Company had net underwriting income of $956,765 in 2002 compared to net underwriting losses of $419,846 and $1,130,535 in 2001 and 2000, 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 2002, the Company earned premiums of $49,812,496 compared to $53,412,569 and $54,378,800 during 2001 and 2000, respectively. Premium income decreased in both 2002 and 2001 compared to the prior year primarily as a result of the redemption of additional series of Shares during the years ended December 31, 2002 and 2001, 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 losses and administrative expenses during the year ended December 31, 2002 of $48,855,731 compared with $53,832,415 and $55,509,335 for the years ended December 31, 2001 and 2000, respectively. Expenses in 2002 were comprised of losses paid and provisions for losses incurred, ceding commissions and excise taxes totaling $48,179,913 and operating expenses of $675,818. Losses incurred in 2002 were $35,671,233 compared to $39,224,574 and $40,702,668 in 2001 and 2000, respectively. The incurred loss ratio for the year ended December 31, 2002 was 71.6% compared to 73.4% and 74.9% for the years ended December 31, 2001 and 2000, 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 that 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 additional business from the Company if the Company does experience significant adverse underwriting results.
During 2002, the Company entered a recapture agreement with MIC for one series of Participating Stock. Under the agreement MIC recaptured premiums of $1,635,656, which represents unearned premiums and an amount equal to $57,426 for losses incurred, but unpaid in respect to the recaptured business as of June 30, 2002. Additionally, MIC paid the Company a recapture commission of $391,954 and a refund of U.S. Federal Excise Tax of $16,357, which represents the deferred portion of the ceding commission and taxes previously paid by the Company.
The Company incurred operating expenses during the year ended December 31, 2002 of $675,818 compared to $749,181 and $663,358 for the years ended December 31, 2001 and 2000, respectively. Such amounts do not include expenses reimbursed by MIC as noted below. The decrease in operating expenses for the year ended December 31, 2002 compared to the year ended December 31, 2001 was primarily attributable to a decrease in legal fees and a decrease in the costs associated with the annual general meeting of the shareholders. The increase in operating expenses for the year ended December 31, 2001 compared to the year ended December 31, 2000 is largely attributable to special reviews of certain operations of the Manager that were performed by the Company's auditors during 2001 and increased legal fees. MIC has agreed to pay directly certain costs relating to registering and issuing Shares if such costs cannot be allocated to the Subsidiary Capital Account for the Common Stock. For the year ended December 31, 2002, $90,753 of such costs were paid directly by MIC compared to $106,751 and $98,992 for the years ended December 31, 2001 and 2000, respectively. The decrease in such costs for the year ended December 31, 2002 compared to the year ended December 31, 2001 is largely attributable to a reduction in fees associated with the issuance of Participating Stock.
The sale of investment securities for the year ended December 31, 2002 resulted in realized gains of $2,099,677, compared to realized gains of $1,632,053 and realized losses of $313,531 for the years ended December 31, 2001 and 2000, respectively. Interest earned for the year ended December 31, 2002 was $4,268,676 compared to $4,518,711 and $5,122,439 for the years ended December 31, 2001 and 2000, respectively. Interest earned in 2002 compared to 2001 decreased slightly as a result of a decrease in interest rates in 2002 and the reduction in invested assets arising from premiums paid to MIC on quarterly reinsurance cessions. Interest earned in 2001 compared to
2000 decreased primarily as a result of the combination of (i) repayment during the first quarter of 2000 of premiums paid to MIC with respect to the 37 unprofitable series of Shares that the Board voted to redeem (the "Recapture"), which represented approximately 20% of the invested assets of the Company, (ii) the movement of investment funds into the equity fund, and (iii) lower interest rates in 2001.
Based on market values at December 31, 2002 approximately 14% (2001-18%/2000-19%) of the Company's investment portfolio was invested in a U.S. dollar denominated international equity fund and the remaining 86% (2001-82%/2000-81%) was invested in U.S. dollar denominated fixed-income securities.
Net unrealized losses on investment securities held at December 31, 2002 were $1,157,908 compared to unrealized gains at December 31, 2001 of $1,769,048. This decrease resulted primarily from a significant change in the unrealized position on the Company's equity portfolio, which was largely attributable to overall negative performance of the equity markets during 2002.
During 2002, the Company recorded a realized loss for other than temporary impairment of $0.2 million and $0.0 for its fixed income and equity investments held, respectively. These impairment charges did not have a material impact on other investments held. To determine the amounts 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 was determined to be other than temporary in nature, the underlying security's cost basis was written down to the market value at the time that the impairment charge was recorded.
As of December 31, 2002, the Company's fixed income portfolio was in an unrealized gain position of $2.6 million and its equity investment in the Fund was in an unrealized loss position of $3.8 million. Utilizing the procedures described above, no charge for other than temporary impairment was recorded in 2002 for the Company's investment in the Fund. This conclusion was based on the procedures described above, the volatility of the Fund over the last year and the ability to be able to recover from unrealized loss positions in a reasonable period of time. As of February 28, 2003, the net unrealized loss position of the Fund was $4.4 million or 27% of its historical cost. Management will continue to monitor the unrealized loss position of this investment and, if necessary, record an impairment charge.
The fair value of the Company's investments that are in an unrealized loss position and the duration that they have been continuously in an unrealized loss position at December 31, 2002 are as follows:
Pursuant to the Retrocession Agreement, the Company must furnish to MIC collateral in the form of an irrevocable letter of credit of at least 12 months in duration and for an amount equal to the unearned premium with respect to risks retroceded and unpaid loss reserves (including reserves for losses incurred, but not reported) otherwise required to be maintained by MIC with respect to the Policies.
Low end of range: $2.4 million High end of range: $3.5 million
Key assumptions made in determining the actuarial range of reserves for unpaid losses include the following:
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 less open claims at a given point in time.
Prior to the 4th Quarter of 2001, reserves for unpaid losses were recorded based on a higher percentage of earned premiums for the corresponding quarter. Utilizing this percentage of the corresponding quarterly earned premiums was appropriate at that time as the carried reserves for unpaid losses fell within the acceptable minimum and maximum range for such reserves developed by the ceding company's actuaries. Taking into consideration the efficiencies that were achieved in the claim payment processes of the ceding company, it was determined appropriate to reduce this factor. Such efficiencies included, among other things, the greater utilization of electronic claim settlement processes (including the ability to submit many types of claims electronically and the empowerment of eligible dealers to submit the payment of claims without requiring pre-approval by an adjuster). As improvements occurred in the claims payment processes of the ceding company, such efficiencies were reflected in the loss reserve factor utilized. Since the last reporting date, there have been no significant changes in the key assumptions made to estimate the reserves for unpaid losses. In addition, there have been no changes in the nature and timing of the change in estimate, including new events that occurred since the last reporting date.
SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities", issued in July 2002, addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The principal difference between Statement 146 and Issue 94-3 relates to Statement 146's requirements for recognition of a liability for a cost associated with an exit or disposal activity. Statement 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. A liability for an exit costs as generally defined in Issue 94-3 was recognized at the date of an entity's commitment to an exit plan. Therefore, this Statement eliminates the definition and requirements for recognition of exit costs in Issue 94-3. This Statement also established that fair value is the objective for initial measurement of the liability. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. We do not believe the adoption of this statement will have a material impact on the Company's results of operations or financial position.
Statements of Cash Flows for the years ended December 31, 2002, 2001 and 2000 31
We have audited the accompanying balance sheets of Motors Mechanical Reinsurance Company, Limited (the "Company") as of December 31, 2002 and 2001 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, 2002. 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, 2002 and 2001 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, 2002 in conformity with accounting principles generally accepted in the United States of America.
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 determine the amounts recorded as other than temporary impairment for its fixed income investment 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 to hold the investment; and the security's rating as determined by an independent rating agency. If an investment's unrealized loss position was determined to be other than temporary in nature, the underlying security's cost basis was written down to the market value at the time that the impairment charge was recorded.
1. Reviewing 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. Reviewing the volatility of the Fund to determine if there has been a demonstrated ability for it to recover from an unrealized loss position. 3. Examining the concentration of the Fund from a geographical, industry, and individual security standpoint.
In 2002, gross gains of $3,516,788 and gross losses of $1,417,111 were realized. In 2001, gross gains of $2,067,143 and gross losses of $435,090 were realized. In 2000, gross gains of $1,735,049 and gross losses of $2,048,580 were realized. For the years ended December 31, 2002 and 2001, of the realized loss recorded, $159,632 and nil, respectively was recorded for investments whose losses were determined to be other than temporary.
At December 31, 2002, the investment portfolio is comprised of approximately 86% (2001 - 82%) in diverse debt securities, which do not result in any concentration of credit risk and 14% (2001 - 18%) in an international equity fund based on market value. At December 31, 2002 and 2001, 100% of the Company's investments are denominated in United States dollars.
In the years ended, December 31, 2002, 2001, and 2000 costs in the amount of $90,753, $106,751, and $98,992, respectively, were incurred in the sale of Participating Stock. MIC reimbursed the Company directly for these expenses. Such reimbursements are deducted from the gross administrative expenses of the Company.
Insurance Corporation, but unearned at the respective period ends. The amounts will be received as the premiums are earned, net of related acquisition costs.