Mercury Insurance 2010 Annual Report Download - page 28

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The Company’s ability to access capital markets, its financing arrangements, and its business operations
are dependent on favorable evaluations and ratings by credit and other rating agencies.
Financial strength and claims-paying ability ratings issued by firms such as Standard & Poor’s, Fitch, and
Moody’s have become an increasingly important factor in the ability for the Company to access capital markets.
Rating agencies assign ratings based upon their evaluations of an insurance company’s ability to meet its
financial obligations. The Company’s financial strength ratings with Fitch and Moody’s are A+ and Aa3,
respectively; its respective debt ratings are A and A3. On January 21, 2011, the Company terminated its rating
service with Standard & Poor’s. On January 25, 2011, Standard & Poor’s released a closing rating of BBB+, and
has informed the Company that it will continue the rating on an unsolicited basis until the senior notes mature on
August 15, 2011.A lowering of the existing ratings could limit the Company’s access to the capital markets or
adversely affect pricing of new debt sought in the capital markets in the future. These events, in turn, could have
a material adverse effect on the Company’s financial condition, results of operations, and liquidity.
The Company received approval from the California DOI for an extraordinary dividend, of which a portion
of the proceeds will be used to repay the $125 million senior notes maturing on August 15, 2011. Once the notes
are repaid, the Company will not have public debt and has no intention of raising public debt in the foreseeable
future. Consequently, the Company is reducing the number of its paid rating services.
Changes in market interest rates or defaults may have an adverse effect on the Company’s investment
portfolio, which may adversely affect the Company’s financial results.
The Company’s results are affected, in part, by the performance of its investment portfolio. The Company’s
investment portfolio contains interest rate sensitive-investments, such as municipal and corporate bonds.
Increases in market interest rates may have an adverse impact on the value of the investment portfolio by
decreasing realized capital gains on fixed income securities. Declining market interest rates could have an
adverse impact on the Company’s investment income as it invests positive cash flows from operations and as it
reinvests proceeds from maturing and called investments in new investments that could yield lower rates than the
Company’s investments have historically generated. Defaults in the Company’s investment portfolio may
produce operating losses and negatively impact the Company’s results of operations.
Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and
international economic and political conditions, and other factors beyond the Company’s control. Although the
Company takes measures to manage the risks of investing in a changing interest rate environment, it may not be
able to mitigate interest rate sensitivity effectively. The Company’s mitigation efforts include maintaining a high
quality portfolio and managing the duration of the portfolio to reduce the effect of interest rate changes. Despite
its mitigation efforts, a significant increase in interest rates could have a material adverse effect on the
Company’s financial condition and results of operations.
The Company’s valuation of financial instruments may include methodologies, estimations, and
assumptions that are subject to differing interpretations and could result in changes to valuations that may
materially adversely affect the Company’s financial condition or results of operations.
The Company employs a fair value hierarchy that prioritizes the inputs to valuation techniques used to
measure fair value. The fair value of a financial instrument is the amount that would be received to sell an asset
or paid to transfer a liability in an orderly transaction between market participants at the measurement date using
the exit price. Accordingly, when market observable data is not readily available, the Company’s own
assumptions are set to reflect those that market participants would be presumed to use in pricing the asset or
liability at the measurement date. Assets and liabilities recorded on the consolidated balance sheets at fair value
are categorized based on the level of judgment associated with the input used to measure their fair value and the
level of market price observability.
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